Bad News for ELSS Investors

The Indian Income Tax policies as per the budget this year has had its share of good as well as bad news. While everyone expected a significant hike in tax slabs and section 80C, the reality was far from what was expected. To know more about the Indian Income Tax policies click here

Though there wasn't much change in these areas, there was however one significant news. This news affects all Mutual Fund Investors who invest in ELSS Mutual Funds to reap the benefits offered under Section 80C. The purpose of this article is to elaborate on that new policy and to analyze how it affects us.

So, lets get started!!!

What is ELSS?

Well, this is something we have covered in various articles in my blog in the past. ELSS stands for Equity Linked Saving Scheme and is a variety of Mutual Fund that invests in the stock market as well as provides tax benefits to investors under the section 80C of the Indian income tax policies. To know more about ELSS you can refer to the below articles:

What is ELSS

Saving Tax through Investments

Now that we have covered the basics, lets get down to business.

What is the current state of ELSS in India?

Until now, Equity Linked Service Scheme (ELSS) has been one of the first-choice mutual funds for Indian investors. As you might have read in the article on what is ELSS, It has two main benefits:
1. It helps you to save tax and
2. It helps you to invest in the stock market.

The 3 year lock-in period ensures that the investment is long-term and also is protected from market fluctuations. Market Statistics reveal that Rs 23,700 crores worth of ELSS schemes have been invested in May 2010 as compared to Rs 11,800 crores in May 2007. Between 60-120 lakh people regard ELSS as a tax-saving investment and are invested in the various ELSS schemes available in India.

What is DTC?

DTC stands for Direct Tax Code. It determines what income in India is taxable and the kind of taxes individuals who earn an income in India have to pay.

Impact of DTC 2011 on ELSS Investments

The DTC code 2011 has significantly affected ELSS Investments in India. This is because:

Starting April 1, 2012, no new ELSS Mutual Funds will be exempted from taxes taking away one of the biggest motivators of ELSS Investment. This is likely to hit the investors as well as the Mutual Funds industry hard.

How does this affect us?

Well, this is really bad news because – Starting April 1st 2012, all fresh investments into ELSS schemes will no longer be eligible for tax benefits. Which essentially means that ELSS mutual funds are no longer an option for tax saving.

I personally feel that the best option to save tax for the younger generation has been taken away from Investors.

Is it sensible to still invest in ELSS?

The important point to be noted here is that according to the revised 2011 Direct Tax Code, only ELSS Mutual Funds initiated after April 1, 2012 will not be exempted from tax deductions. This does not apply to already existing ELSS funds and investments made before the aforementioned date, so it would be to wise to avail this offer while it is still available. So, you can still invest in ELSS mutual funds for this financial year 2011 – 2012 and reap the benefits they offer before the validity period runs out…

What will happen to the ELSS Funds Starting April 2012?

They will become regular Equity Mutual Funds. They will still continue to operate as regular equity oriented mutual funds that investors can invest in, with two major differences:

1. There will be no tax benefits on investing in ELSS funds &
2. There will be no 3 year lock-in period.

To sum it all up in one word – ELSS schemes will no longer be a separate class of Mutual Funds and would become regular Equity Oriented Mutual Funds.

What has happened because of this new DTC Ruling?

Despite the fact that tax benefits for ELSS funds already in existence will continue, there has been a rush among investors to exit these schemes. ELSS was considered a sort of starting point for budding investors as they made their entry into the equity market, but with the coming of the DTC this looks certain to change. From next year onwards, there are no tax benefits for investing in these schemes and hence they will become less and less favourable for investors and people will start exiting them, big time. So, the NAVs of your funds might drop significantly.

What should we do now?

Below are some options that are available for us. They are based on your situation:

1. If you are a seasoned ELSS Investor (Someone like me who started investing in ELSS schemes years ago) and your investments are past the 3 year lock-in period then:

a. Check the performance of the fund in the past one year and if their performance is not at par with the best performing Equity Diversified Mutual Funds – Exit them and invest in a well performing regular Equity Diversified Mutual Fund Scheme
b. If your fund is performing very well, keep your fingers crossed and review the funds performance once every 2-3 months and exit the scheme at the point where you feel the fund isn’t performing as well as it is supposed to be.

2. If you have just started investing in ELSS Schemes in the past one or two years:

a. Wait till your investments complete the mandatory 3 year lock-in period. Once it completes 3 years, check out your options as mentioned in point 1 of this section and exit the funds, the moment you feel the fund NAV is falling significantly.

3. If you are a new Investor considering ELSS as an investment option:

a. You have only one year to take advantage of the tax benefits
b. So, invest in the best ELSS mutual funds available in the market and keep your exposure limited
c. Do Not Invest in newer or smaller ELSS MFs that aren’t performing as well as their experienced cousins

Is it the End of the Road for ELSS Schemes?

Well, to be honest, the answer is Most Probably Yes. There might be no fresh investments into ELSS schemes and hence, they might run out of business in the next 4-5 years. So, personally I would suggest you check out other investment options for tax saving and regular Equity Diversified Schemes for Mutual Fund Investments.

But, and this is a big BUT, a point to remember is that, this DTC is just a draft bill and is yet to be passed as a law. If in the next one year (before April 1 2012) the bill doesn't become a Law, ELSS funds might continue to provide tax benefits to Indian investors.

So, lets keep our fingers crossed and hope for the best!!!

Types of Equity Mutual Funds

We all know what a mutual fund is. A Mutual fund is nothing but a common pool of money collected from investors and managed by a fund manager who would buy/sell stocks on our behalf and share the profit/loss with us. To know more about mutual funds click here

If somebody is talking about mutual funds, almost always they talk about equity mutual funds.

What is an Equity Mutual Fund?

A MF scheme that invests at least 65% of its fund corpus into equity and equity related instruments is called an equity mutual fund. Equity funds carry the most risk among all kinds of MFs because they invest in the stock market. This risk comes with the potential of high returns.

Types of Equity mutual funds:

Based on the investing style equity mutual funds are broadly classified into 4 categories:

1. Equity Diversified funds
2. Equity Linked Saving Schemes (ELSS)
3. Index funds & ETFs
4. Sectoral Funds

Equity Diversified Funds:

These are actively managed funds that invest across stocks and sectors. They do not concentrate on only a few sectors or scrips but focus on either large-caps or mid and small caps. They could also be thematic, for instance funds focusing on rural growth or infrastructure. These funds are riskier than index funds because their performance depends on the fund managers abilities to buy and sell the right stocks at the right time.

The top 3 Equity diversified funds are:

1. ICICI Prudential Infrastructure fund
2. Reliance RSF – Equity
3. UTI dividend yield fund

ELSS funds:

ELSS are also diversified equity funds but offer income tax deduction under sec 80C up to a limit of Rs. 1 lakh. It also imposes a three year lock in period. You cannot redeem your units before the end of 3 years.

The top 3 ELSS funds are:

1. Sundaram BNP Paribas tax saver
2. SBI Magnum Tax gain
3. Fidelity Tax Advantage

Index Funds:

These are the simplest and least risky of all equity funds. They invest in all the scrips and in exactly the same proportion as the scrips lie in their underlying benchmark indices. While an index fund buys and sells scrips on the stock exchanges, an ETF (Exchange Traded Fund) appoints market participants. They exchange a basket of securities (whose composition exactly matches that of the benchmark index) against an ETF unit. These ETF units are then traded on stock exchanges like stocks.

While index funds can be bought or sold from the MF or through an agent like any other ordinary scheme, ETFs can only be bought and sold on exchanges, therefore you need a DEMAT account to buy/sell them.

Sectoral Funds:

These are the riskiest of all funds. They invest in a single or at best two or three closely linked sectors. Their fortunes depend on these select sectors & its stocks only. As their name indicates, the fund house buys/sells stocks only in the sector on which it declared to invest while offering the fund. If the sector that the fund house invests performs well then our returns would be more than a equity diversified fund or an index fund but at the same time, if a sector underperforms our returns would get affected adversely. These funds are not for the normal investor. It is only for high risk and knowledgeable investors who can actively track their portfolio and exit a sector before it is adversely affected.

Note: This is not a recommendation to buy the mutual funds mentioned in their respective categories. This is just an illustration to point out the best funds in the categories as per my view as of today April 5th 2009. The funds performance may change its ranking over the next few weeks/months/years.


Happy Investing!!!

Equity Linked Savings Scheme (ELSS)

With March just around the corner, people have started worrying about saving Income tax. Usually people throng investment options during February and March and try to save as much tax as possible. To know about the Indian taxation laws pls Click Here

As per our Indian IT laws every tax payer is eligible for savings under section 80C for amounts up to Rs. 1,00,000/- To know about the various options that we have to save tax under section 80C pls Click Here

This article is about Equity Linked Savings Scheme (ELSS). ELSS schemes are one the best tax saving instruments that have been offering great returns for our investor public over the years.

What are Equity Linked Savings Schemes?

An ELSS is a kind of Mutual Fund and is similar to any diversified equity mutual fund in many ways. An ELSS gives a tax benefit and comes with a lock in period of 3 years. Investment avenues of an ELSS are a mix of various asset classes such as equity, debt, gold and real estate.

Some advantages of ELSS are

* The 3 year lock in period prevents withdrawals and thus allows your money to grow over a period of time. Long term investment in equities gives better returns than any other investment instrument.
* It gives tax benefits (Up to 30% for people in the highest tax slab)
* Gives the flexibility to invest small amounts through a Systematic Investment Plan (SIP)

As an ELSS investor, your interests will be safeguarded by two separate market bodies. The Association of Mutual Funds in India (AMFI) and the Securities and Exchange Board of India (SEBI)

Let me explain the returns on an ELSS with an example:

Lets assume you invest Rs. 1 lakh this year in an ELSS scheme and you are in the highest tax bracket.

Invested Amount = Rs. 1,00,000/-
Income Tax saved = Rs. 30,000 (30% tax slab)

Net amount Invested = Rs. 70,000/- (I have deducted the 30,000 because you get it back up front after your investment as income tax benefit and you effectively invested only Rs. 70,000)

Let us assume your equity investment grows at the rate of 15% per annum.

Investment value at the end of the First year = 1,15,000/-
Investment value at the end of the Second year = 1,32,250/-
Investment value at the end of the Third year = 1,52,087/-

Assuming you encashed your investment at the end of the 3rd year you will get Rs. 1,52,087/-

Profit you realized = Rs. 82,087/- (You invested only Rs. 70000 effectively :) remember the tax saved)

Profit percentage = 117% (For 3 years together)

Returns % per year = 39%

A Returns of 39% per annum is something we cannot expect in any other form of investment. Thus ELSS schemes make one of the best investment options.

How is your ELSS Money Invested?

This is a very common question that people have. The asset allocation is pre-determined and is in accordance with SEBI guidelines. Between 60% to 100% is invested in equities, cumulative convertible preference shares and fully convertible debuntures and bonds of companies. Money market instruments account for anything between 0% to 20% The asset allocation shows a tilt towards equities which has the scope for providing good returns for us. The choice of industries and allocation to mid-cap and large-cap companies depends on the individual scheme & its fund manager. As an investor, we must first understand the objectives of the fund and also go through the offer document before investing.

Difference between an ELSS fund and a Equity Diversified Mutual Fund

Both ELSS and Diversified equity schemes have the same risk profile. Both are high risk - high return investment avenues. The major difference lies in the fact that an ELSS scheme has a lock in period if 3 years and a diversified equity scheme comes with no such conditions.

It is always advisable that Equity investments be made for the long term to help the fund outperform other asset classes. The lock in period for ELSS supports this view and also allows the fund managers to plan a strategy that would be beneficial in the long term. On the face of it, the 3 year lock in stipulation might be a deterent to investors, but it has its own advantages.

* By forcing us to wait 3 years, it makes us take a long term view of the market, which induces investing discipline to a certain extent
* The real potential for returns from equities can be realized only if we stay invested for at least a few years
* The fund manager knows that the investment would not be encashed in the next 3 years and hence they can plan and devise a strategy that can help us benefit. The manager can choose the sector and stock bets with freedom that he does not get in regular equity schemes

The performance of an ELSS and a diversified fund may also vary.

The difference in performance usually arises from the differences in managing styles and the market rewards for a particular style at a given time. ELSS schemes may have a small & mid cap bias. Fund managers may like to take advantage of the lock in period to exploit value stories in these sectors. Many diversified equity funds tend to have a large cap and growth bias. Therefore, during periods when growth stocks and large caps dominate, diversified equity funds would outperform ELSS Schemes.

But if we calculate the returns of ELSS schemes including the tax benefits we get out of it, they would outperform the diversified equity class.