ELSS Funds: Still Attractive?

In the ever-evolving landscape of financial investments, equity linked saving schemes (ELSS) were once a popular choice among investors looking for long-term wealth creation. But with the implementation of the new tax regime in India, are ELSS funds losing the sheen of providing dual benefits of tax deductions and capital appreciation? Vardan Pandhare explores the various intricacies in this story. [EasyDNNnews:PaidContentStart]

Despite the turbulence witnessed in the domestic stock markets, net investments in equity funds have persisted in a positive trajectory for the 31st consecutive month. However, in September, the inflow into equity mutual funds saw a decline of more than 30 per cent, amounting to ₹14,091 crore. The data also indicated that Large-Cap funds, in particular, continued to witness outflows. So, what does it say about ELSS mutual funds? Do they still hold the charm? 

However, certain questions linger. How can your investment in ELSS mutual funds contribute to your long-term wealth creation goal? What sets it apart from other mutual funds? Our article will serve you as a guide to ELSS mutual funds. It will steer you through fundamental concepts and strategies and also explore the impact of the new tax regime on ELSS funds.  

Understanding ELSS Mutual Funds
Equity linked saving schemes (ELSS) in the past few years were among the favoured mutual funds. They belong to the equity funds category, predominantly channelling investments into equities. Earlier, one standout feature of ELSS mutual funds was their eligibility for deductions on the invested amount, up to a specified limit under Section 80C of the Income Tax Act, but as the new tax regime got introduced, most of the tax-saving benefits went away. Another crucial aspect worthy of examination is the obligatory lock-in period of three years. 

During this period, you are precluded from withdrawing or redeeming your investments. This constraint plays a pivotal role in fostering substantial growth over an extended timeframe. While investing in ELSS serves as a commendable means of diversifying your investment portfolio, it is not immune to market risks. Furthermore, ELSS serves as a blend of a taxsaving mutual fund and an investment growth vehicle, making it particularly conducive to achieving your financial objectives. 

How Does ELSS Fund Work?
ELSS mutual funds represent a category of diversified equity funds. Their core investment strategy centres on the purchase of shares from publicly listed companies, spanning the spectrum of market capitalisation, including large-cap, Mid-Cap and Small-Cap stocks, across various sectors. The overarching objective of these funds is to optimise capital growth over an extended investment horizon. To achieve this goal, fund managers employ their expertise and conduct exhaustive market research, meticulously selecting stocks for the fund’s portfolio. This process is carefully designed to yield an ideal balance between risk and returns. 

Impact of the Old and New Tax Regimes
The ongoing discourse, both among financial analysts and on social media, centres on the implications of the older and newer tax regimes following the recent alterations in direct taxes as per the Union Budget 2023. A prominent contention in this debate asserts that for individuals falling within the income bracket of less than ₹15 lakhs, the new tax regime offers a more favourable tax structure due to the comparatively lower tax rates within various Income Tax slabs. The standout feature of the new tax regime is that it completely waives off Income Tax liability for income up to ₹7 lakhs.  

In contrast, the old tax regime allows for various deductions, which are unavailable in the new regime. Therefore, the question arises: Which tax regime is more advantageous? The answer is far from straightforward, hinging on the extent to which deductions can be claimed. For those taxpayers adhering to the old tax regime, tax-saving instruments will continue to hold their appeal. Conversely, individuals opting for the new tax regime may find tax-saving instruments somewhat less enticing. To comprehend these scenarios, it’s imperative to delve into the rebates offered by both the old and new tax regimes. 

Which is Better – ELSS or Flexi-Cap?



The standard deviation is slightly higher for flexi-cap funds than for ELSS funds. This means that flexi-cap funds are slightly more volatile than ELSS funds. The Sharpe ratio and Sortino ratio are both higher for ELSS Funds than Flexi-cap funds. This indicates that ELSS funds have generated higher returns per unit of risk than Flexi-cap funds. The beta of both ELSS funds and flexi-cap funds is close to 1. This suggests that both types of funds are expected to move in line with the market. The alpha of both ELSS funds and flexi-cap funds is positive. This signifies that both types of funds have generated excess returns over the market. The R-squared of both ELSS funds and flexi-cap funds is high, which means that both types of funds have a strong correlation with the market. 

Do ELSS Funds Create Wealth?

We have emphasized the potential of ELSS funds in nurturing long-term wealth throughout this report, and now let’s delve into the mechanics of this wealth creation process.
■ As an equity-based investment, ELSS funds inherently offer superior returns when compared to conventional fixed deposits. This advantage forms the bedrock of long-term wealth generation.
■ ELSS funds facilitate long-term wealth creation through the magic of compounding, thanks to their predetermined lock-in period. This compounding effect allows your investments to snowball over time.
■ Professional fund managers oversee ELSS funds, actively monitoring the dynamic market conditions. This expert oversight minimises risk and bolsters the assurance of wealth accumulation over the long haul.
■ The ability to reinvest dividends offers yet another avenue for long-term wealth creation. This strategy ensures your wealth continues to grow steadily.
■ ELSS, as a tax-saving mutual fund, emerges as a prominent instrument for generating substantial long-term wealth while concurrently securing tax benefits.
■ Furthermore, ELSS funds enforce a disciplined investment approach, discouraging impulsive decisions and ensuring that your money multiplies over the long term. This disciplined strategy significantly contributes to sustained wealth accumulation. 

Old Tax Regime versus New Tax Regime 

The 2023 Union Budget elevated the Income Tax exemption from ₹2.5 lakh to ₹3 lakh for the old regime and increased the rebate from ₹5 lakh to ₹7 lakh for the new regime. A crucial point of distinction is that the old tax regime necessitates disclosing one’s income and offsetting it with savings and investments in tax-saving instruments to determine the actual taxable income, subject to the respective tax slabs.  

For those adhering to the old regime, they qualify for tax rebates only after accounting for savings of up to ₹1.5 lakh under Section 80C. In contrast, the new tax regime does not incorporate such provisions. Taxpayers opting for this regime are exempt from Income Tax on earnings up to ₹7 lakh. Beyond this threshold, they are subject to the tax slabs stipulated by the government. Importantly, the new regime does not factor in savings or investments, as they bear no relevance. 

So, is investing in tax-saving instruments worthwhile under the new tax regime? Absolutely, yes! It’s essential to acknowledge that tax saving should not be the sole determinant when considering investments covered by Section 80C. Tax-saving instruments like ELSS, PPF and NPS, among others, hold appeal not only due to the potential tax rebates they offer but also because they serve as a secure means of building substantial long-term wealth. 

While PPF assures fixed returns, ELSS and NPS stand out as attractive market-linked investment vehicles, poised to deliver higher returns. Moreover, these instruments feature relatively short lock-in periods, ensuring investors remain engaged through market fluctuations. This approach ultimately yields significant returns, surpassing the returns provided by most fixed deposits. While PPF and NPS enjoy recognition among both categories of taxpayers, ELSS remains somewhat less explored, despite its potential for remarkable returns. 

Performance Analysis of ELSS Funds

Let’s decipher the category returns, comparison and look at the best-performing funds in the ELSS realm. 

ELSS funds have showcased their mettle as an investment option with a consistent and competitive performance record. Over the past three years, ELSS funds have generated an impressive average return of 21.55 per cent, and their five-year performance stands at 15.75 per cent. This performance not only qualifies them as a potential tax-saving avenue but also as a source of wealth creation. In comparison to other mutual fund categories, ELSS funds have held their own remarkably well. They have notably outperformed several categories, such as sectoral-banking, thematic-energy and sectoralpharmaceutical across most timeframes.  

Their standout performance lies in their ability to deliver competitive returns while offering the added benefit of tax-saving, making them an attractive option for investors. But do note that ELSS funds have underperformed in most other categories in the three, five and 10-year periods. This is likely since ELSS funds tend to have a higher lock-in period and are also subject to Capital Gains Tax. 

Key Considerations for Investing in ELSS Funds

1. Fund Performance Analysis - Before selecting an ELSS fund, it’s crucial to assess its historical returns concerning its peers and the benchmark index. The aim is to determine whether the fund has consistently outperformed its competition over time. While no fund can consistently rank at the very top, high-quality funds tend to remain in the upper quartiles for extended periods.
2. Fund House Track Record - Opt for fund houses with a track record of consistent performance spanning five to ten years. A fund house’s historical performance demonstrates its ability to manage funds effectively and provide investors with reliable returns.
3. Expense Ratio Evaluation - The expense ratio quantifies the percentage of your investment allocated to fund management. Lower expense ratios translate to higher take-home returns for investors. Therefore, it’s advisable to opt for funds with lower expense ratios to maximise your returns.
4. Financial Metrics Assessment - Several financial parameters, such as standard deviation, Sharpe ratio, alpha and beta offer insights into a fund’s performance and risk profile. Higher standard deviation and beta values indicate greater risk, while a higher Sharpe ratio signifies superior risk-adjusted returns.
5. Fund Manager Proficiency - The fund manager plays a pivotal role in managing your investments. It’s essential to evaluate the manager’s competence and experience in selecting the right stocks and constructing a robust portfolio.
6. SIP or Lump Sum - When contemplating ELSS investments, consider whether you prefer a systematic investment plan (SIP) or a lump sum approach. SIP involves regular – typically monthly – investments, enabling cost averaging. It results in acquiring more units when the market is down and fewer units when it’s up. Alternatively, lump sum investments involve a substantial one-time investment. 

In general, SIPs are favoured for their cost averaging benefits. They provide investors with a more balanced approach to market volatility. However, if you possess surplus funds, lump sum investments are also an option. Your choice should align with your financial goals and risk tolerance. 

Conclusion
When it comes to choosing between the old and new tax regimes, the utility of ELSS funds is firmly established in the former. However, if you are inclined towards the new regime, don’t hastily dismiss ELSS without a second thought. If you already have a substantial investment in ELSS funds, it’s prudent to remain invested as long as the funds continue to perform well. For those seeking fresh investment opportunities, it’s advisable to evaluate ELSS funds just like any other mutual fund category. Their historical track record of strong performance speaks for itself. Furthermore, investors who might be inclined to make impulsive selling decisions can use ELSS funds as a hedge against their behaviour, benefitting from the stability they offer in the investment landscape.

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