ELSS or the Equity Linked Savings Schemes are back in the limelight after the union Budget 2014-15 raised the limit of deduction under section 80C from the existing Rs 1 lakh to Rs 1.50 lakh. This is an important move which can help save tax on the additional Rs 50,000 compared to the previous financial year. Considering the move as a good one for individuals and HUF who are covered under the purview of the new guideline, it is pertinent to understand how one can utilize this opportunity to not just save tax but also build on the investment capital.

Although there are a lot of investment opportunities available, the one which can give good returns on the invested capital is the ELSS which is part of mutual funds qualifying under the 80C deduction.

Earlier with limit of upto Rs 1 Lakh, most people did not have to look at any investment as, PF, home loan principal, insurance would cover most of it. Now the window of additional Rs 50,000 has surely raised an important question, where to invest?

Long Term View

The markets have been ringing new highs and, more importantly, are sustaining at the level following the results of elections. There might be many factors in the short run which may render markets volatile but the long-term view sounds good equivocally from all market experts. This is one of the reasons why mutual funds are as well coming up with closed ended equity schemes as what they are eyeing is picking up quality stocks at good price and holding on to them until their full potential is realized. This liberty of holding on to the stocks might not be fully available in open ended funds where one sees constant redemptions and purchases.

ELSS or tax saving mutual funds have a lock-in of three years which is lower than any other tax saving instrument available coupled with the potential to generate higher returns makes it important and also an attractive investment option.

The current market conditions where most of the factors look positive build a strong case for investment in ELSS schemes. The general expectation from the markets by the experts as well as investors alike is that the markets are heading for the next bull run which will last for some time and hence equity investment with a time horizon of three years and above can be expected to give strong performance.

Before discussing little deep into the current portfolio construction and performance of the schemes, let us look at other investment option which invests in stocks ala ELSS schemes, they are ULIPs or Unit Linked Insurance Plans. These insurance schemes are more of an investment rather than a security cover as the sum assured is lower compared to the traditional plans which offer higher sum assured for a lower investment. Hence, ULIP can be a part of the larger insurance planning for self but cannot be considered in isolation.

If we compare keeping aside the insurance coverage aspect and considering both as pure investment option then ELSS scores higher in terms of lower charges and lower lock-in both of which hold high importance in investors perspective.

Now coming to the important part as to what are the few parameters which can be considered while selecting the ELSS schemes for investment.

How To Pick It Right

Even if the historical performance does not guarantee future performance, it still reflects a lot in terms of how the scheme has been handled.

However, unlike looking at point to point performance for periods ranging from 6 months to 5 years alone, it would be ideal to top this up with 3-year performance for the periods since inception, for example a fund launched in 2007 performance will be seen for periods 2007-10, 2008-11, 2009-12, 2010-13 and 2011-14 along with their benchmarks to see how they have fared against their benchmarks.

The information might not be easily available, but still since the period of investment is 3 years, one may not be very excited in what the scheme has delivered in 6 months or 1 year. However, this data cannot be ignored as this shows how the schemes have readjusted to the changing trends and how they have performed with respect to their benchmarks.

It is advisable for the investors to check with their advisors to provide the data at least for the schemes which are present for over 5 years.

Portfolio Making

Many investors believe the fund which is performing well is deemed to have a good portfolio. However, this is an important factor as it has to be in line with your investment objective. As an investor investing for three years and above horizon, one might be willing to invest in schemes which have higher exposure to mid-caps or large-caps or small caps varying from investor to investor.

When one builds a portfolio they generally have allocation towards asset classes (equity, debt, gold) and then they also further breakdown the asset classes into sub-asset (large cap, mid cap, small cap, long term debt etc.) based on the risk appetite.

Even if the investment in ELSS is for the purpose of saving tax, it still is an investment and equal importance has to be given to the kind of exposure one takes at least at the time of investment as ELSS schemes’ portfolio allocations might change subsequently depending on the perceived changes in the market trends.

More than 75% of the schemes have more than 80% of their portfolio in the large caps. Only 31% schemes have more than 10% exposure into mid caps.

Dividend History

As the ELSS is a lock-in product, the only option where the investor has a chance of getting the part of the profits before the lock-in period ends is the dividend option. A mutual fund company has the discretion of paying to the investors a part of the profit/ appreciation earned as and when they believe there is surplus. However, it must be noted that it is not an obligation for the mutual fund company to always share the surplus for the investors who have chosen dividend option. But, for investors who believe there might be turbulent times in the markets and it seems wiser to get some profits before the lock in period ends, then dividend is the option one has to choose. Also, dividends are tax free in the hands of the investor which makes it quite attractive.

So, for investors looking for dividend option, having a look at the dividend history is a good option. It gives a clear picture of how the schemes have paid dividends over a period of time. As the general market condition over a period of time is constant for all schemes, this gives quite a clear study on the willingness of the schemes to pay dividends.

Dividend option further has two sub options, payout and reinvestment. The option so far discussed is the dividend payout.

With respect to dividend reinvestment, it is important for an investor to note that the reinvestment amount will be locked in for three years from the date of reinvestment as it will be treated as a fresh investment. Under the reinvestment option, the dividend amount declared by the mutual fund company is reinvested at the revised/lower NAV which will be treated as fresh investment and will be locked in for a period of three years from date of reinvestment.