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Get tax benefit from mutual funds! Here's how

By Sunita Abraham, Outlook Money
Last updated on: February 09, 2007 10:41 IST
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Taxing times are here again. For most of us, this would mean parking more money in PPF or NSC to earn tepid returns, just to claim the tax break.

This year, if you are looking to save tax and earn relatively higher returns, we suggest you take a look at Equity Linked Saving Schemes (ELSS). Coupled with other benefits such as shorter lock-in periods and tax-free dividends, the ELSS is definitely worth a slice of your Section 80C investments.


ELSS is like any other diversified equity fund but investors can avail tax benefits, provided the investment is locked-in for a period of three years. How do these schemes stack up against other instruments permitted for tax planning?

The best performing ELSS scheme gave a three-year return of 64.5 per cent, while the worst performer in the period gave a return of 19.88 per cent. The 8 per cent return from PPF and NSC hardly compare.

ELSS scores on the liquidity front too, with a lower lock-in of three years compared to the PPF's 15 years and six years of the NSC.

Unlike assured return schemes, ELSS does not guarantee returns, but if you are comfortable with taking a moderate risk for higher returns, ELSS is just the product for you.

Which ELSS?

Outlook Money offers you a shortlist for selecting the ELSS that is ideal for you. While the category as a whole has given impressive returns, we have selected five schemes that are definite candidates in any selection process.

To remove period bias from the return, rolling returns were considered to shortlist these schemes. Other factors such as portfolio composition and risk-adjusted return (RAR) were considered to ensure that the risk is lower.

Franklin India Taxshield: This scheme, which has given steady returns since its inception, makes the grade on consistency. It is suitable for investors who are not looking for fireworks in their returns and are uncomfortable with volatility. It has a comparatively lower exposure to mid-caps and that explains the lower returns of 34.49 per cent that the fund has generated in the three-year period as compared to its peers.

There is a high degree of concentration in the portfolio with the top five holdings constituting a huge 29.76 per cent and the top three sectors constituting almost 50 per cent of the portfolio. This exposes the scheme to the risk of under-performance by these companies/sectors.

HDFC Taxsaver: This is a star performer from the HDFC stable. In the one-year and three-year periods, its returns were 33.92 per cent and 51.70 per cent, respectively.

The scheme has a large-cap focus with the flexibility to move to other segments. This has helped the scheme generate good returns in most scenarios. It has a new fund manager and it remains to be seen if the fund will continue its past excellence.

Principal Tax Savings Fund: Principal tax saving scheme has rewarded investors with returns of 43.87 per cent, 41.99 per cent and 48.59 per cent, over one, three and five years, respectively.

The fund has consistently outperformed the category average by a wide margin since the portfolio was recast in 2004-05 to have greater exposure to mid- and small-cap stocks. Holding in individual companies do not exceed five per cent and top five companies constitute only 22 per cent of the now diversified portfolio. The smaller size of the fund, at around Rs 176, crore makes for easier implementation of fund management strategies.

Prudential ICICI Taxplan: This is the scheme for you if you are comfortable with higher risk for higher returns. With a portfolio that has more than 90 per cent in small-and mid-cap stocks, the fund gave excellent returns in 2004 and 2005 when these sectors outperformed the broader markets.

The fund returned 44.95 per cent in the last three years and 51.90 per cent in the last five years. With a one-year return of 25.92 per cent, the scheme has under-performed due to the poor run that the mid- and small-caps have had in the last six months.

The corpus of Rs 574 crore (Rs 5.74 billion) makes it one of the larger schemes. Finding avenues in the mid- and small-cap segment to deploy funds may become an issue.

SBI Magnum Tax Gain Scheme 93: This scheme finds a place in the best tax savings schemes on the strength of its outstanding performance in the last two years.

The scheme turned the corner in 2003, with a shift in focus to mid-cap stocks, and has since outperformed the benchmark as well as peers by a wide margin. It has given returns of 44.55 per cent, and 64.51 per cent in one- and three-year periods.

The fund has now reduced mid-caps and increased large-cap stocks in the portfolio though mid-caps continue to have a dominant share. The scheme is suitable for investors comfortable with some volatility in returns.

The growth in the corpus, which stood at Rs 1,163 crore (Rs 11.63 billion) in December 2006, makes the fund less nimble, especially when investing in mid- and small-cap stocks, and the change in the management team since last year are triggers that the investor must watch out for.

When to buy ELSS?

Timing entry into these schemes to take advantage of dividend declarations or lower NAVs when markets fall is not a sustainable strategy. Ideally, use systematic investment plans (SIPs) as they work to your advantage in a volatile market and a small investment made periodically is less heavy on the pocket than a lump sum one-time investment. Most SIPs can be started with an initial investment of Rs 5,000 and periodic investment of Rs 500.

ELSS provides the booster in returns to your tax planning. The ELSS, with its three-year lock-in, imposes a long-term investing discipline. However, the lock-in also has a flip side. If you make a wrong selection, you do not have an exit option for three years. This is where an existing scheme scores over a new fund offer as it gives you an idea of the efficiency of the fund management in good and bad markets.

The road ahead for your tax investments is clear. Evaluate and select a scheme, start an SIP, and have a well-balanced tax-planning portfolio.

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Sunita Abraham, Outlook Money

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