Best Tax Saving Mutual Funds

The year 2009 has arrived and has brought with it the need for investors to make quick fixes to their investment plans in order to save on tax payments. The last few years have seen India Inc growing at an enormous pace, which has made sure that the income in the hand of the individuals has shot up significantly. Consequently, tax planning forms for an integral part of an individual’s life. Thus, with the season for filing returns closing in, everyone is now in a rush to get certain investments in place and thereby get the maximum of their income under the umbrella of tax exemption as available under Section 80c. But we would rather suggest that investors should make it a regular exercise and invest systematically throughout the year instead of these last minute hustle and bustle.

The US financial tsunami has swiped away all the good work done by the fund managers over the years and has left grim numbers for the investors to worry about. Last year’s fall has resulted in turning the one-year and three-year return columns into red for most of the equity funds. Thus, at this point of time, depending on an individual’s risk-taking ability, it is important for one to select a tax saving avenue available u/s 80c from the table on the next page.

The ELSS Advantage
So why should one invest in the ELSS scheme over other tax exempt investment avenues u/s 80c? The answer is simple: it has the minimum lock-in period of three years, the capital gains arising out of the investments are considered to be long term & hence tax free and the dividends in the hands of investors are also tax-free. And lastly, the returns from the ELSS scheme have the zest of the equity market. Another icing on the cake for the investors is that the markets have corrected sharply making the units of the funds currently available at lower NAVs, providing better scope for upward movement.  Most of the other options available u/s 80C are debt instruments, which have fixed payout rate but the interest is received at the maturity of the instrument. And unlike other options u/s 80C, ELSS allows the investors to get the part of their income in terms of dividend even before the maturity of the instrument. Also, ELSS schemes over the last several years (barring last one year) have given out fantastic dividends to its investors. One has to note that the three-year returns from the ELSS category have been negative. However, the post-tax return for the ELSS category still stands positive. Let us understand this with an example: Mr ABC whose income falls in the highest tax slab (30 per cent) invested Rs 1[PAGE BREAK] lakh in the ELSS scheme in January 2006 and received tax benefit on it. Considering the current ELSS category return of minus 5 per

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cent annually, Mr ABC’s current value of the investment stands at Rs 85,738. However, one has to also consider the tax of up to Rs 33,990 saved by him on the investment of Rs 1 lakh made in 2006. This brings his net investment down to Rs 66,010 (1,00,000-33,990). Thus, at the end of three years, Mr ABC has earned 29.89 per cent absolute returns on the net investment.  And looking at the risk-reward scenario for mutual funds in the long term investment horizon, investors with higher risk appetite can select ELSS funds amongst the below options that are available u/s 80c.  We would also advise investors to select an ELSS scheme not only for tax-saving purpose but also to consider it as a long term investment avenue. The lock-in period of three years is a big benefit for investors in a way that one can plough the proceeds from the redeemed amount back into any ELSS fund or other tax-saving instruments after three years, and forget the problem of liquidity (if any) and avail of the benefit of tax-saving. And secondly, if there is any long term capital loss arising out of selling of the ELSS scheme, then it can be set off against the long term capital gains. Let us understand it by a simple example: Mr XYZ is an entrepreneur who had invested Rs 1 lakh in an ELSS scheme in January 1, 2006 to save tax on his income. On January 10, 2009, he realizes that he needs to invest again in the ELSS scheme in tune with his yearly exercise. But he faces some liquidity problem due to poor market conditions. Thus he redeems the ELSS investment made in 2006 and due to the current state of the equity markets he receives only Rs 85,738 on his investment. And by adding Rs 14,262 to the proceeds, he invests Rs 1 lakh in the ELSS scheme to save tax for this accounting year. In addition, he can set off the loss of Rs 14,262 against the long term capital loss (if any). And thus, after three years of consecutive investment in the ELSS schemes, these investments become self-sustaining to enable future ELSS investments for Mr XYZ. [PAGE BREAK]

In Comparison With ULIP
ULIP is the option available u/s 80C which comes close to match the returns given by the ELSS funds. It also provides insurance cover. However, when we consider the cost involved in both the instruments, ELSS again stands out to be a winner. For ELSS, there are two types of costs applicable on the investment, direct and indirect. The direct cost is the entry load (one time) which is 2.25 per cent in most of the funds. However, one has to note that as per the SEBI’s guidelines, AMCs cannot charge any entry load on direct investments in the open-ended funds. The indirect costs are the annual recurring expenses that cannot be more than 2.50 per cent as capped by SEBI. In case of ULIP, the cost is as high as 40 per cent of the premium for the first year. This reduces the total amount invested in the equities and thereby drastically reduces returns from the investment on a compounded basis.

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And finally, in the recent melt-down, the MF industry on a whole has witnessed redemption pressures across funds, leading the fund managers to spend sleepless nights for deciding the asset reallocation of their funds. However, the three-year lock-in for the ELSS schemes provides great flexibility to fund managers to plan the asset allocation for long term and allows enough freedom to take a long term call without worrying about the redemption pressures. ELSS forces you to take a long term view of the market and induces investing discipline. And since equities work better in the long term, in such testing times one can also consider ELSS as a better investment option as compared to other equity mutual funds.

In accordance with our annual exercise, we bring you the six best schemes under the ELSS gamut that will not only offer you tax exemption u/s 80 C but will also provide you with one of the best investment avenues to grow your money. The methodology that we followed to select these ELSS schemes is given alongside.

Our advice to investors is to invest regularly in the ELSS schemes through SIP and select dividend option. One should consider tax planning as a boon and not a curse. We wish all the investors happy tax saving and not to forget, investing.

Sundaram BNP Paribas Tax-Saver Fund
Launched in 1999, this fund is a top performer in the ELSS category and has managed to beat its peers’ returns as well as the benchmark returns by miles in both, short term as well as long term periods. This consistency of performance has helped this fund to form a part of our recommendation for the second time in two years. The fund has managed to deliver remarkable returns and has also showcased an ability to contain the downside during the volatility of the last one year.  In the one-year period, the fund's performance has helped it stand at the number one position in the ELSS category. [PAGE BREAK]

It is a multi-cap fund that currently has a major exposure towards large-caps and decent exposure towards the mid-caps. It selects the stocks using a blend of growth and value style of investing. As at the end of December 2008, the fund had a slightly concentrated portfolio wherein the top three sectors were financial services, energy and consumer goods which contributed to 56.80 per cent of the portfolio. Out of its portfolio of 34 scrips, the top five stocks contributed 23.50 per cent. While one has to also note that the fund‘s portfolio churning is on a higher side which might result in higher transaction cost, however the funds performance do compensate for such higher cost. The fund’s opportunistic asset allocation strategy of having a higher portfolio turnover during the recent market swings seems to have enhanced its performance.

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The fund has very low exposure to aggressive sectors such as infrastructure and realty. Its exposure in sectors like consumer goods and pharma was nearly 19 per cent, thereby enhancing the defensive orientation of the portfolio. Such tactical sector allocation helps the fund to reduce the risk of portfolio concentration. Satish Ramanathan has been managing this fund from September 2007 and since then the fund has been leading in terms of category performance. At Sundaram, Satish also manages six other funds and most of them have performed reasonably well. This one, however, tops it all. Therefore, investors with a slightly higher risk appetite can take exposure to this fund and also avail of tax benefits.

SBI Magnum Tax Gain
Consistent performance is what this 16-year-old fund has managed to showcase in all these years. This fund has been a top performer in the ELSS category for a five-year period. However, in the shorter term, the fund has only managed to give returns that were in tune with the category. This fund had been featured in last year’s ELSS Cover Story as well as the Fund Of The Fortnight column in our Issue No 14. It has now come to be a part of our recommendations even this time around.

The fund is currently the largest ELSS fund due to its size in the mutual fund sector. It is a large-cap biased fund and selects stocks that display a blend of both growth and value. However, recently the style has been more favourable to growth. In December 2008, the fund’s top three sectors that contributed 38.10 per cent of the portfolio were financial services, energy and industrial goods. It has very low exposure to low risk sectors like FMCG and pharma. However, the top five scrips make for only 15.76 per cent of the 75-scrip portfolio, thus suggesting that the stock portfolio is well diversified. However, the disadvantage is that while such diversification might reduce the risk of the portfolio, it might not help the fund to out-perform during market rallies. [PAGE BREAK]

Jayesh Shroff has been managing this fund for more than a year and it has, in this period, put up an average performance as compared to its category. At SBI he also manages funds like SBI Magnum Equity, Multiplier Plus and Infrastructure Series-I. Out of these four funds, three funds have managed to beat the category returns in the long term phase. The fund is currently sitting on a huge pile of cash that is in the tune of 26 per cent of the portfolio or Rs 643.39 crore as the fund manager expects the market to bottom out in the near future. Thus, deploying cash at current lower levels might help in enhancing the fund’s performance. Conservative investors would do well to take exposure in this fund.

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HSBC Tax Saver Equity
The fund was launched in January 2007 and despite the fact that it still hasn’t completed three years, it has managed to form a part of our recommendation. The reason for selecting this fund is that it has managed to out-perform the category returns on a consistent basis. This is an actively managed multi-cap fund that changes the sectoral allocation strategy depending on prevailing market conditions. And as per the fund manager, the fund was aggressive in 2007 with significant exposure to the mid-cap as well as the small-cap stocks and was fully invested. Last year the fund was defensive and invested mostly in the large-cap segment and also had a large amount of cash in the portfolio. Such strategies have enhanced the fund’s performance.

In December 2008, the top three sectors contributed 43.63 per cent, while top five stocks contributed 27 per cent of the portfolio. The fund is currently playing defensive which is evident from the fact that a major chunk of the portfolio is invested in large-caps and it holds almost 10 per cent of the portfolio in cash. Besides, since the second half of 2008, the fund has been overweight on defensive sectors like consumer non-durables and pharma, while in the last quarter it has increased its exposure in banks.

The rationale behind such a sectoral allocation was that these are mainly driven by domestic demand which might get least affected by the current global and local crisis. The fund has a concentrated portfolio with 32 stocks and a higher bit of churning. However, the fund’s performance does justify for the higher risk taken by the fund manger. It has very low exposure to aggressive sectors like infrastructure and realty. [PAGE BREAK]

This fund has been managed by the astute fund manager Mihir Vora since its inception. This ensures stability and consistency in funds investment style and performance. At HSBC, Mihir also manages six more funds and most of these funds have managed to beat the performance of their categories. Due to its lower track record and allocation strategy, we would recommend investors with slightly higher risk taking ability to take limited exposure to this fund.

Franklin India Taxshield Fund
Franklin India Taxshield is a well diversified tax saving fund holding 44 scrips. The fund follows passive investment strategy of buy & hold, and focuses on long term investment in companies that have the best trade-off between earnings growth potential, business and financial risk, and valuation. The fund was launched in 1999 and has formed a part of our selection on account of its decent track record in both short term as well as long term periods. The fund believes in long term investing and adopts a bottom-up approach to select companies with good fundamentals across market cap ranges and sectors.

As per the fund’s December 2008 fact sheet, almost 45 per cent of the portfolio was invested in sectors like consumer non-durables, banks and industrial capital goods. And the top five stocks contributed almost 28 per cent of the portfolio. One has to note that the fund has a very low portfolio turnover of 63.45 per cent because of its buy and hold strategy. Thus this fund might do well during adverse times to restrict the fall. In addition, it might find it difficult to out-perform during rallies in the market. The fund’s cash level is quite low as compared to other funds. However, it is has primarily invested in the large cap space and has a defensive sectoral exposure.

Since April 2007, this fund has been managed by Anand Radhakrishnan who has done a wonderful job so that the fund has been able to comfortably beat the category returns. At Franklin Templeton India, Radhakrishnan also manages funds like Franklin India Bluechip, Pharma (recently featured in our Fund Of The Fortnight column), Infotech Fund, and equity portfolio of all Hybrid Funds. He is also a co-portfolio manager for Prima Plus and High Growth Companies Fund. Most of these funds have managed to out-perform their category returns in the long run. The fund normally has very low cash holdings and currently it has 6.36 per cent of cash as the fund house doesn’t believe in taking cash calls on the funds portfolio. Therefore, to go by the fund’s defensive asset allocation strategy, we would advise risk-averse investors to invest in this fund. [PAGE BREAK]

Reliance Tax Saver Fund
Reliance Tax Saver is the second highest fund in terms of the corpus that stood at Rs 1,326.24 crore at the end of December 2008. The fund has managed to form a part of our recommendation on account of its decent performance in both the long run as well as the short run. However, the fund’s performance in the short run is much better as compared to its performance in the long run. The fund follows a multi-cap approach and currently it is mainly invested in the large-cap space. However, it also has a decent exposure towards mid-cap and small-cap stocks. As per the December 2008 fact sheet, the top five stocks contributed 24.97 per cent of the portfolio.

And the fund’s top three sectors were banks, pharma and software that contributed 32.37 per cent of the portfolio. The rationale behind such sectoral allocation is that the fund manager is bullish on the domestic driven sectors and technology. Currently the fund is sitting on cash of almost Rs 277.66 crore or 20.95 per cent of the portfolio that also includes the fund’s derivative and debt exposure. Looking at the points that the portfolio is diversified and is currently holding a good amount of cash, one can conclude that the portfolio is quite defensive. However, looking at the fund’s market cap allocation, the portfolio does come across as slightly aggressive.

The fund has been managed by Ashwani Kumar since it was established in September 2005. This ensures stability and consistency in the fund’s investment style and performance. And since its inception, the fund has managed to out-perform many of its peers in the ELSS category. Kumar has over 15 years’ experience in equity research and over five years’ experience in fund management. At Reliance, he also manages funds like Reliance Vision, Equity Advantage, Natural Resources and Monthly Income Plan. And all these funds have managed to out-perform the category returns with ease.

The fund’s asset allocation has a blend of aggression as well as defense and thus investors with moderate risk appetite can take exposure to this fund.