EQUITY LINKED SAVINGS SCHEMES (ELSS)

An Equity Linked Savings Scheme (ELSS) is an open-ended Equity Mutual Fund that doesn't just help you save tax, but also gives you an opportunity to grow your money.

Equity-linked saving schemes are among the options that are eligible for tax benefits under Section 80C. Here are some facts that will help you make better investment decisions.

1) What are the tax benefits?

Up to Rs 1.5 lakh invested in ELSS funds in a year is eligible for deduction under Section 80C. (FY 2014-2015 & 2015-2016) However, unlike the life insurance policies, you cannot invest on behalf of a minor and avail of tax deduction. No tax is levied when you redeem your investment after the lock-in period.

Since ELSS funds have more than 65% of their corpus invested in stocks, they enjoy the exemption from tax on long-term capital gains as is the case with any other equity fund. The dividend income is also tax-free.

arameter	PPF	NSC	ELSS
Tenure	15 years	6 years	3 years
Returns	(Compounded Annually) 8.80 % ^	(Compounded half-yearly) 8.60 to 8.90 % ^	Not assured dividends/ returns
Minimum investments	Rs.500	Rs.100	Rs.500
Maximum investments	Rs.1,50,000	No limit*	No limit*
Amount eligible for deduction under Section 80C	Rs.1,50,000	Rs 1,50,000	Rs 1,50,000
Taxation for interest	Tax free	Taxable	Dividends and capital gain tax free
Safety/ Rating	Highest	Highest	High Risk

* There is no upper limit on investments. However, investments of only up to Rs.1,50,000 per year are allowed to be claimed as deductions under Section 80C of IT Act.

2) Will you get assured returns?

Since these are essentially diversified mutual funds, there is no guarantee on returns. The ELSS category has given an average return of 11.2% in the past five years. The best performing fund return of 11.2%  during this period, but the worst performing scheme reduced it to 4.2%.

Apart from the performance of the broader market, your returns are dependent on the fund manager's ability to pick the right stocks. This also means you must select the fund after proper research. Instead of picking a fund with high, but volatile, returns, choose one with a stable performance record.

3) What's the lock-in period?

The lock-in period is only three years, the shortest among all tax-saving options under Section 80C. You cannot redeem or switch to another option during this period. In the case of SIPs, each instalment is treated as a separate investment and will have a three-year lock-in period. So, if you started investing in an ELSS fund in April 2012, you can redeem the units bought in the first instalment only in April this year.

The lock-in stipulation does not mean that the investor must compulsorily redeem the funds after three years. Unlike Ulips and pension plans, there is no maturity date of an ELSS fund. If you want, you can remain invested for a longer period.

4) Dividend, growth or reinvestment?

The dividend is only a profit-booking exercise since a fund's NAV reduces by the amount the investor receives as dividend. In the growth option, the amount remains invested for the entire tenure.

The dividend option provides a periodic income to the investor, though there is no obligation on the part of the mutual fund to declare a dividend or maintain its pay-out ratio year after year. The growth option has the potential to generate higher returns. Your choice should depend on your needs and risk appetite. Avoid the dividend reinvestment option because you will find it difficult to exit the fund completely. There will always be some units that have not completed the lock-in period.

5) How should you invest?

Unlike regular equity schemes, the ELSS funds have a lower investment threshold of Rs 500. You can invest a large amount at one go, but the best way to invest in equity-oriented instruments is through regular monthly driblets called SIPs.

Thematic – Infrastructure

Infrastructure funds are part of a mutual fund category called thematic funds.

Infrastructure mutual funds are those which invests in stocks that either directly or indirectly involved in Infrastructure development. Companies which are into Energy, Real Estate, Power, Metal etc. would fall under Infrastructure sector. Companies like Banking, Finance, Transportation, etc. would contribute indirectly to Infrastructure development. Infrastructure mutual funds would invest in all these stocks.

While Sectoral funds invest in particular sectors like, say, information technology, power, metals, oil and gas, etc., thematic funds invests in themes like infrastructure, consumption-led categories like the retail industry and outsourcing companies.

Infrastructure, as a theme, covers several sectors like power utilities, power equipment and construction companies. Unlike technology sector mutual funds infrastructure funds are not restricted to a few sectors.

From a risk point of view, a thematic fund carries less risk than a sectoral fund. The reason being, it’s focused on only two to three sectors. If these sectors do well, so will the fund. But, if these sectors suffer, the fund will suffer too as it lacks diversification. Since thematic funds have a little more diversification they are less risky than sectoral funds.

Diversified Equity Mutual Funds

Diversified Equity funds are those that spread their investments across sectors e.g IT, Pharma, Banking, Oil & Gas, Real estate, Telecom, FMCG, etc. So they are not restricted to one specific sector. They diversify their allocations across sectors and thus minimise the risk of over-concentration in any one particular sector. Over the long term, diversified equity funds have had the best track records.

How to go about - making your money work best for you:-)

There is nothing like starting early, in your investing life and use the power of compounding to your advantage.

Next, you can invest in a mix of the following strategies, depending on your investing risk profile, as indicated below. Invest only those funds that you do not need. Use these funds to invest wisely. You need to remain invested for the long term, since you want capital growth.

Conservative Risk Profile (you seem to be of this type; someone who wants his principle to be secure and is looking for a decent growth over the long term)

It is plain wisdom that to invest in a diversified equity fund, you need to pick the right one that suits your requirement the best. In reality it is easier said than done. When there are more than hundred equity funds claiming best returns in their schemes, it is quite puzzling to zero in on one. And the self-seeking mutual fund agents who survive only by cooking the figures further confound the problem.

To cut through the confusion, you need to have a set of objective factors serving as parameters while selecting the right diversified equity fund. What matters is the performance of a diversified equity fund against all the parameters.

The fundamental thing to remember is that not just one factor makes a diversified equity fund worthy enough to be a part of well-performing mutual fund portfolio. An ideal diversified equity fund must pass all these 6 parameters.

1. Match your investment objective with that of the diversified equity fund

First things first. It is of utmost importance that your investment objective is in tune with the diversified equity fund’s investment objective.

2. Evaluate returns across diversified equity funds within the same class

To compare diversified equity funds within the similar category is one of the essentials for benchmarking a fund. When evaluating a large cap diversified equity fund for investment, you must compare its yield with other matching large cap diversified equity funds.

Comparing it with mid cap diversified equity funds won’t give you the real picture as the risk-reward relationship between both is too wide to compare.

Another factor in evaluating a diversified equity fund is timeframe. Diversified equity funds are designed to deliver returns over long period of years; you should invest in diversified equity funds with a foresight.

Evaluating a diversified equity fund over a longer timeframe helps you gauge its performance during boom and bust periods. You can observe the consistency of the returns of a diversified equity fund by its performance during different market phases combined with the category average.

3. Check diversified equity fund returns against the benchmark index

It is mandatory for every diversified equity fund to mention a benchmark index in its offer document. This benchmark index is the signpost to judge if the diversified equity fund has fared well.

While evaluating the performance of a diversified equity fund against its benchmark index, you should take into account the longer time period. Those diversified equity funds that outperform their benchmark indices constantly are best suited for investment.

In India, most diversified equity funds do better than their benchmark indices over long timeframe. But during choppy times you may find many diversified equity funds lagging behind their benchmark indices. Those diversified equity funds that stay ahead of their benchmark indices during rough times must be earmarked.

4. Evaluate the consistency of the diversified equity fund

Apart from peers and benchmark index evaluation, a diversified equity fund must be judged by its historical performance. Many diversified equity funds don’t stay stable over the years, they take a dip during recessions and sometimes even dip below their benchmark indices and category average.

Only a handful diversified equity funds perform strongly against all odds and display steady performance. Those warriors who brave rough times and display stability are the ones to add to your portfolio.

5. Check the costs associated with the diversified equity fund scheme

Besides performance analysis, you must consider the costs involved with making investment in that particular diversified equity fund scheme as this affects your net returns from that scheme.

Before you make the final decision of investing in a diversified equity fund, you must check its expense ratio. Along with that you should also know the exit load (charges levied by a mutual fund scheme when redeeming within the stipulated period) while asking for redemption from a diversified equity fund scheme.

6. Risk-return analysis of diversified equity funds

To evaluate the performance of a diversified equity fund, it is common to look at its absolute returns. However, that is not enough as diversified equity funds being market-linked are susceptible to stock related risks. Hence, you should not only assess a diversified equity fund on the basis of returns but also take into account the risk involved with the fund.

If you overlook the risk factor, you might lose your hard-earned money. So you must do risk-returns analysis of a diversified equity fund before you invest in it. There are some simple but effective ratios available to be followed:

Alpha: It is a unit of diversified equity fund’s performance on a risk-adjusted basis. Taking the volatility (price risk) of a diversified equity fund, Alpha weighs its risk-adjusted performance to benchmark index. The ratio of excess return of the diversified equity fund to the return of the benchmark is the fund’s Alpha.

Beta: It is also known as the Beta coefficient and calculates the volatility of a diversified equity fund scheme in relation with its benchmark index. You can consider Beta as the tendency of your diversified equity fund’s ability to react to fluctuations in the market or its benchmark index.

If the above two ratios are taken together, it makes apparent that those diversified equity funds that generate high Alpha albeit at lower (less than1) Beta are worthy of investment.

Standard deviation (SD): This is a measurement of the volatility of returns. To get SD, you need to calculate the average returns yielded by the diversified equity fund for a fixed period and then measure the deviation from the mean.

Higher the deviation, greater the standard deviation denoting a highly volatile fund. If you want to avoid high risk, you should choose diversified equity funds with lower SD.

Final note:

Now that you know what to look for in a diversified equity fund, you can pick the right one that meets your investment needs. Keep your eyes open and make an informed decision before you invest.