Selecting a tax-saving fund

This  article specifically looks at equity linked savings schemes, or ELSS, which are diversified equity funds that offer a tax benefit under Section 80C. All tax saving products have a lock-in period and this one is no exception. However, it is only three years, which is perfectly acceptable considering that investments in the stock market must anyway have a long time frame.

Here's what to keep in mind when scouting for an ELSS:

• Keep performance in perspective

As with any fund investment, when narrowing down on a pick, an error investors are prone to make is opting for the most recent chart topper. Despite the bold disclaimers about past performance not necessarily being sustained in the future, investors have a hard time resisting that lure. And when that is employed as a sole parameter, it’s not uncommon for disillusionment to set in rapidly.

Let’s say in 2008 investors rushed to invest in Taurus Tax Shield. The reason being the fund was the best performer in its category in 2007 with a return of 112%, way ahead of the average 57%. Had investors done their homework, they would have noticed the fund’s abysmal performance in 2006. And, unfortunately, the fund has not put up an impressive performance since.

Or take Principal Tax Savings. It was the best fund in its category in 2012. But a smart investor would have checked past performance to realise that it underperformed the category average over the prior four calendar years.

When looking at performance, don’t get swayed by a sporadic burst in numbers. Check for consistency matters. To cite an example, Axis Long Term Equity has been fairly consistent in its performance. Over the past six years, even if it has not always been the best performer (which is an impossible feat), it has always beaten the category average and landed in the top quartile.

Some investors may find that consistency does not really  matter and they are willing to ride it rough. Reliance Tax Saver is an example. The fund was the second best in its category in 2012, leaving the category average way behind. The very next year it slipped down and underperformed the category average only to again bounce back to the No. 2 slot in 2014. But again it slumped and delivered -4.34% in 2015 when the category average was 3.20%. However, the 5-year annualized returns of 14.57% has ensured that investors are well rewarded.

Look under the hood

Once you get past performance, take a good look at the fund's portfolio.

Do remember, these are actively managed diversified equity funds with a tax break. That gives the fund manager complete leeway on what must comprise his portfolio. One fund’s mandate will not be the same as the other. Mirae Asset Tax Saver has around 72% of its portfolio in large caps, HSBC Tax Saver has around 34% in mid and small caps, and Edelweiss ELSS has 44% of its portfolio in mid and small caps. You need to figure out the kind of exposure you are looking for.

If you are looking for a mid-cap fund, then search for a tax-saving fund which has such exposure to smaller fare. If you prefer playing it safe with large caps, then search for such portfolios accordingly.

On similar lines, check whether the fund manager takes big bets or prefers going with a diversified portfolio, and see where your comfort level lies.

For example, the top 10 stocks in JM Tax Gain corner over 51% of the portfolio. The portfolio is completely invested in around 30 stocks. Edelweiss ELSS has just around 32% of its portfolio in the top 10 stocks but sports a portfolio of around 64 stocks.

You also need to look at other aspects. For instance, DSP BlackRock Tax Saver was managed by Apoorva Shah. Last year, he relinquished his role as fund manager. So if investors were investing in that fund based on him being at the helm, they might want to revisit their fund preference.

When Morningstar analysts rate a fund, they follow the 5Ps guidelines: People (caliber and experience of the fund managers and the backing of a research team), Process (does the fund manager stick to his stated mandate and declared investment process), Parent (quality of the AMC and does it keep investors' interest in mind), Performance (long term returns and consistency through market cycles), and Price (expense ratio). You too could keep these factors in mind when scouting for a fund.

When finally investing....

Like any actively managed diversified equity fund, we suggest that the best way to invest in a tax saving fund is via a systematic investment plan, or SIP. This way, you consistently enter the market in an organized fashion irrespective of the state of the market. Unfortunately, if you have delayed your tax planning, then you have no choice but to invest it all in one go now.

As with any equity investment, don’t look at a short-term horizon, especially if you have invested a lump sum. Agreed, you have a time horizon of three years which is forced upon you. But if the market is down at that time, hold on and don’t be too eager to sell. Exit only when the market picks up.