ELSS Fund: It is The Best Tax Saving Scheme

Fist things first, ELSS is NOT a savings plan. It is an investment plan which is equity-heavy, with a lock-in period. Hence offers moderate risk.

What is ELSS? It is an acronym for ‘Equity Linked Savings Scheme’. ELSS is basically a type of mutual fund which closely resembles a multi-cap fund.

But there is a difference between a typical ‘multi-cap’ fund and ‘ELSS’. In terms of portfolio composition both ELSS and multi-cap funds are same. But they differ in two main ways:

• Tax Saving: ELSS allows its investors to save income tax under section 80C. But other typical multi-cap funds do not have this benefit.
• Lock-in: ELSS funds lacks the liquidity benefit which other multi-cap funds provide to its investors. How? Units of multi-cap funds can be sold anytime. But ELSS funds comes with a lock-in period of 3 years (more difference).

We can say that ELSS funds offers benefits of both equity funds and debt plans.

1. ELSS is which type of fund?

Why this question is relevant? Because on one hand ELSS is an equity based fund, on other hand it also saves tax u/s 80C.

So, as an investor, we shall compare ‘ELSS’ with other ‘equity funds’ or with ’80C plans’? ELSS can be compared with both.

But this is also true that ELSS’s resemblance is more with equity funds than with 80C tax saver plans.

We will see their comparison (ELSS vs Multi-cap, ELSS vs 80c) in this article to visualise the difference & similarities better.

In fact a closer resemblance to ELSS (than 80C plans) is with ULIP and NPS. We will also see a comparison of ELSS vs NPS, and ELSS vs ULIP to understand their differences.

2. Who can invest in ELSS?

Two questions first:

• Q1: ELSS being an equity based mutual fund, multi-cap investors can prefer investing in ELSS (over multi-cap)?
• Q2: ELSS is also able to save tax u/s 80C. Hence, shall 80C investors can prefer investing in ELSS (over LIC, PPF, NSC etc)?

Young Investors

ELSS is best for first time, young investors, who’ve just joined a job and would like to save tax under 80C. Traditionally such investors start with endowment plans, NSC, PPF, tax saver FD’s etc.

But compared to these investment options, ELSS is more suitable. Why? Because, as holding time for such investments are long, hence ELSS can give much better returns.

By investing is ELSS, young investors can get the benefit of equity growth, and can also save income tax.

Middle Aged

For such investors, who have already exhausted their 80C limit, for them multi-cap funds or ELSS are same. Both can offer similar growth rates. The only rider here is, ELSS has 3 year lock-in period (see ELSS vs multi cap).

Having said that, it is also true that for majority of us, 80C is often over packed with investments like LIC’s, NSC, tax saver FD’s etc. If one has the option of freeing up some space in 80C, it would be nice to fill the free space with ELSS.

This is one way of increasing the yield of 80C portfolio by adding equity to it.

2.1 Why not ULIP or NPS?

ULIP and NPS are also equity based plans, and they can also save tax u/s 80C. But again, their selection will depend on the investor’s priority.

People who buy ULIP and NPS has a different investment goal. Their priority is insurance and retirement respectively.

NPS is tailor made for retirement goal. Unlike traditionally retirement focused investments, NPS has liberty to invest in equity. ELSS also invest in equity, but it scores over NPS is terms of liquidity. ELSS has 3 years lock-in, while in NPS money gets locked till retirement. Read more about NPS here.

People whose priority is fixed income generation after retirement, NPS offers a safer bet. See comparison of NPS with ELSS here.

ULIP is more of a life insurance plan than an investment option. They are like an endowment plan but with better returns. People who desire to buy an insurance plan, can consider ULIP.

This investment vehicle can give both life cover and capital appreciation. ELSS does not provide insurance cover. See comparison of ULIP with ELSS here.

3. Portfolio Composition of ELSS Fund

Portfolio composition of few randomly selected ELSS funds, in terms of their asset size, is shown below.

What is portfolio composition? Proportion of equity, debt, cash etc included in portfolio.

Name	AUM (Rs.Cr.)	Equity %	Debt %	Cash %
Axis Long Term Equity	21,492	95.31	5.01	0
Nippon Tax Saver (ELSS)	10,674	98.48	0	1.52
HDFC Tax Saver	7,414	94.04	0	5.96
SBI Magnum Tax Gain	7,358	96.83	0	3.17
ICICI Pru LT Equity (Tax Sav)	6,525	95.95	0	4.05
Average	–	96.12	1.00	2.94

What does this analysis prove? It proves that ELSS fund is a pure equity based investment vehicle.

So what? There is no equity based investment vehicle like ELSS, which can also qualify for 80C deduction.

A combination of high returns, income tax saving (u/s 80C), and reasonable liquidity makes ELSS a near perfect investment option.

3.1 Break-up of Equity Composition of ELSS

ELSS funds generally include which type of stocks in its portfolio? All stocks can be categorized into three broad types (based on their market capitalisation): (a) Large Cap, (b) Mid Cap, and (c) Small Cap.

ELSS funds are heavy in which type of stocks? To understand this, let’s see the equity break-up of randomly selected ELSS funds:

Name	Large Cap %	Mid Cap %	Small Cap %
Axis Long Term Equity	75.26	23.19	1.55
Nippon Tax Saver (ELSS)	58.19	27.34	14.47
HDFC Tax Saver	83.04	11.74	5.21
SBI Magnum Tax Gain	71.7	18.55	9.76
ICICI Pru LT Equity (Tax Sav)	72.8	14.59	12.62
Average	72.19	19.08	8.72

ELSS’s portfolio is mostly large-cap stock heavy. What does this analysis prove?

The equity component of ELSS funds is reasonable diversified between variety of stocks. How we can look at its equity portfolio composition? Check this:

• Mid/Small Cap: Inclusion of these stocks gives boost to its long term returns. Though it also imparts volatility to ELSS’s daily NAV. But considering that ELSS funds has a lock-in period of 3 years, short-term price volatility will not effect its investors. Read: Penny stocks.
• Large Cap: Inclusion of more of these stocks makes ELSS’s NAV stable. Why? Because price of large cap stocks are more stable. Though these stocks do not grow as fast (as small & mid cap stocks), but their presence imparts stability to the portfolio. Read: Blue chip stocks.

Such a mix of stocks confirms that, ELSS is a multi cap fund where majority if of large cap stocks.

4. Returns of ELSS Funds

Considering that ELSS is a type of multi-cap equity fund, its long term returns must be high. In India, average return of an equity dominant portfolio should be 12%+ p.a.

Let’s see the long term performance of all ELSS funds clubbed into one specific category (Equity: ELSS):

Name	3-Year	5-Year	7-Year	10-Year
Equity: ELSS	11.17%	7.76%	13.09%	10.96%

[Source: Value Research Online]

Seeing above numbers, ELSS has performed as per expectation (12%+ returns) only in 7-year time horizon. It has not performed as well in 4-year, 5-year, and 10-year time horizons.

Let’s compare these numbers with average returns generated by Multi-cap funds:

Name	3-Year	5-Year	7-Year	10-Year
Equity: ELSS	11.17%	7.76%	13.09%	10.96%
Equity: Multi-cap	11.49%	7.95%	12.88%	11.17%

[Source: Value Research Online]

You can see the numbers and deduce that performance of ELSS and Multi-Cap funds has been almost identical.

[P.Note: ELSS being a tax saver mutual fund, gains of ELSS funds will be slightly enhanced (as shown in above table) if we’ll also consider the tax-saved u/s 80C.]

5. Comparison: ELSS vs Multi Cap Funds

Here is a quick comparison between ELSS and Multi-cap funds. Though there is not much to pick between the two, but I’ve highlighted few key elements.

Description	ELSS	Multi-Cap
Type	Equity Heavy Fund	Equity Heavy Fund
Tax Saver (U/s 80C)	Yes	No
Lock-in Period	3 Years	No Lock-in
Return (3-Year)	11.17%	11.49%
Exit Load	NIL	1% if before 1 Year
Expense Ratio	High: 2% – 2.5%	Low: 1% – 2.5%
Portfolio Composition
– Equity	95%+	95%+
– Debt	< 5%	< 5%
– Large Cap	Yes	Yes
– Mid Cap	Yes	Yes
– Small Cap	Yes	Yes

Considering that, traditional multi-cap funds has lower expense ratio, the possibility of a multi cap fund beating ELSS with long term returns is higher.

6. Comparison: ELSS vs 80C Plans

Traditionally, 80C Plans are mostly debt based. Hence they yield low returns. But inclusion of ELSS, ULIP and NPS in 80C has increased the yield of section 80C.

Allow me to highlight the main differences between ELSS and traditional 80C plans:

Description	ELSS	Endow*	PPF	NSC	Tax-FD
Average Returns	12%	5%	7.6%	7.6%	7.6%
Lock-in Period	3 Year	10 Year	15 year	5 Year	5 Year
Taxable Return	10% above 1 Lakh	No	No	Tax Slab	Tax Slab
Risk of Loss	Moderate **	Risk Free	Risk Free	Risk Free	Risk Free
Max Investment (Rs.)	No Limit	No Limit	1.5L	No Limit	No Limit
Max Tax Saved (Rs.)	1.5L	1.5L	1.5L	1.5L	Rs.1.5L

[* Endow = Endowment plan offered by insurance companies.]

Why I’ve indicated risk of loss as “Moderate” for ELSS? ELSS being a multi cap fund should be in “high risk” category. But considering that there is a lock-in period of 3 years, risk of short-term volatility vanishes. If one hold’s equity fund for about 3+ years, risk of loss is minimal.

Moreover, it must also be noted that one is not allowed to redeem their units of ELSS mutual funds before 3 years. The lock-in period of 3 years is a mandatory requirement.

This is both a limitation and a boon. Why boon? Because after 3 years of holding a good equity fund, positive returns are almost certain.

7. Comparison: ELSS vs NPS

NPS is a tailor made investment option for retirement goal. It helps people to lock their investment till retirement. Moreover, even after retirement, it asks people to invest a portion of their corpus is a certain way (40% in annuity).

Though these restrictions looks beneficial, but often such limitations prove detrimental to investors sentiments. Hence in terms of liquidity of invested money, ELSS looks like a better option than NPS.

Description	ELSS	NPS
Average Returns	12%	10%
Lock-in Period	3 years	Till Retirement
Premature Withdrawal	Not Possible	Restricted
Withdrawal after lock-in	Free	60% can be withdrawn. 40% to buy annuity.
Equity	95%+	50%-75%
Minimum Investment	Rs.500	Rs.250
Max Investment	No Limit	No Limit
Max Tax Saved	Rs.1.5 Lakhs	Rs.2.0 Lakhs (80C & 80 CCD)
Taxable Return	LTCG is applicable (10% above 1 lakhs)	Tax Free
Risk of Loss	Moderate	Safer than ELSS

Read More: About National Pension Scheme (NPS).

8. Comparison: ELSS vs ULIP

ULIP plans have many downsides over ELSS. The main downside is the “exit plans”. ULIP simply does not want their investors to exit early.

First they have a lock-in of five years. If for some reason you exit before 5 years, money will be paid only after 5th year. That’s understandable.

But the money that will be paid after 5th year will be a fraction of premiums paid. Why? Because most of the cost of ULIP are front loaded. Hence to get some positive gains out of it, holding period must be long enough (10+ Years).

Compared to ULIP, ELSS has a much simpler exit rules.

Description	ELSS	ULIP
Purpose	It is a growth plan	Insurance plan which also gives growth
Average Returns	12%	6% – 10%
Lock-in Period	3 years	5 years
Premature Withdrawal	Not Possible	Not Possible
Liquidity	Cash-in possible only after 3 years	Cash-in possible only after 5 years
Premature closure	SIP can be stopped mid way.	Premium Payment can be stopped.
Premature closure Penalty	N/A	Penalty is High
Equity	95%+	40% – 50%
Max Investment	No Limit	No Limit
Max Tax Saved	Rs.1.5 Lakhs	Rs.1.5 Lakhs
Taxable Return	10% above gains of 1 lakhs	Gains are Taxable as per ones tax slab
Risk of Loss	Moderate	Moderate

Read More: About Unit Linked Plans (ULIP).

Conclusion

A person investing in ELSS fund can claim a maximum deduction of Rs.1,50,000 under section 80C. So, from of view of equity and tax-saver investors, here is a point to note:

• Equity investors: They already invest in traditional multi-cap fund. Why they should go for ELSS? Because ELSS fund can also give them income tax relief. Very few equity based investment can also save tax. Moreover, returns of ELSS almost matches that of Multi-cap funds (see here).
• Tax Savers: People who invest in 80C to save income tax can hardly generate more than 7.5% returns from this portfolio. But ELSS is one options which can generate a return of 12%+ per annum. Moreover the money parked in ELSS is also more liquid compare to other 80C plans (see here).

For me, ELSS is one of the better equity based investment plans. Out of Rs.1,50,000 deduction available u/s section 80C, at least 50% of it must come from ELSS.