6 Best Tax Saving Schemes

Along with the delight of entering a new decade comes anxiety for many inverstors who want to minimize their tax component while simultaneously maximize the returns that these investments will generate. One way to achieve both these objectives is by investing in Equity Linked Saving Schemes (ELSS). Though there is a plethora of tax-saving instruments available at the disposal of investors, very few of them are as attractive as ELSS. Other tax-saving instruments that are available in the same category and which offer the same tax benefits are National Savings Certificates (NSC), Public Provident Fund (PPF) and LIC policies among others.

Though investing in these instruments does offer the important benefit of tax saving, ELSS scores over them on two counts. First is the lock in period. Both PPF and NSC come with a relatively longer lock-in period (it is 15 years for PPF and six years for NSC). ELSS too comes with a lock-in period but with a lesser duration of three years. These schemes operate just like any normal equity diversified schemes as they need to invest 80 per cent or more of their corpus in equity and equity-related instruments. Nonetheless, the lock-in period of ELSS allows fund managers to take a longer term view of the market, which always gives a better return than any other investment avenue in the longer run without worrying about redemption pressures. A shorter lock-in period also offers investors the advantage of reinvesting the redeemed amount after three years in turn helping them manage their cash flows. What it means is that the units which have already completed the mandatory lock-in period of three years can be used to purchase fresh ELSS units from the redemption proceeds hence saving on any fresh commitment of funds and at the same time getting tax benefits.

Another way in which the ELSS’ have an advantage over other tax-saving instruments is the option of dividend distribution that all the schemes offer. Since most of the investment in ELSS is made in equity, which is very volatile and unpredictable, it is better to have a bird in hand than two in the bush. What it really means is that one should opt for the dividend option as it helps in booking profit from time to time and that in turn generates cash flow for the investor which can again be reinvested in these instruments or can be pocketed, depending upon an individual’s requirement of funds. This particularly helps in a scenario where the markets tumble very badly as had happened in 2008. Investors may recall that it was during this period that the total gains registered by investors during the preceding two years were entirely wiped out for those who hadn’t booked their profits. So far so good but what if someone needs the money before the completion of the mandatory three years? In such a situation one can redeem his/her units but the tax benefits enjoyed earlier on these investments become income for the year in which the units are redeemed.[PAGE BREAK]

Now let us compare the most important element and that is the returns these investments provide. Since 1993, the average returns given by the Sensex in any three year period is 18 per cent compared to eight to 13 per cent given by NSC and PPF. But such high returns do come with some risks attached to it. In a total of 18 counts, there are three occasions when the market has given a negative return whereas other investment avenues have given fixed returns. From the above discussion it is fairly clear that ELSS is an investment vehicle which is more suited for those investors who are in the higher tax bracket, are looking for higher returns and have an appetite for risk. We have selected six such schemes out of 37 and we suggest our readers can opt for any three funds depending upon their requirement and risk appetite.

HDFC Long Term Advantage Fund

The HDFC Long Term Advantage Fund saw its Assets Under Management (AUM) double between 2008 and 2010. On the back of some phenomenal returns it has provided, it is our top pick among the ELSS schemes. The AUM has increased from Rs 507.45 crore at the end of 2008 to Rs 1,024 crore at the end of 2010. In terms of performance, in the last one year and three year period, the fund has outperformed the category returns by 927 and 612 basis points respectively.

The fund’s portfolio that used to be predominantly concentrated in mid-cap stocks during its earlier years has now shifted its focus to large-cap stocks. Currently it has about 57.9 per cent of its total assets in large-cap and giant stocks. It primarily follows a growth investment style and invests in growth stocks. ICICI bank has retained the top slot in its portfolio for a while and SBI has made its way to the top three holdings along with TCS, replacing Reliance Industries. Stocks from the financial, technology, healthcare and automobile sectors continue to be the fund’s preferred choice. These sectors alone accounted for 49.2 per cent of the net assets. What is also distinct about the fund is that it is one of the least diversified funds and is concentrated in only 36 stocks.

From the fund’s history of cash holding, it seems that it does not believe in timing the market and deploys most of its cash in the equity market. It has always maintained a lower cash holding of less than three per cent barring the last quarter of 2008 when it was holding more than five per cent of its net assets in cash. Chirag Setalvad, Senior Fund Manager at HDFC AMC is handling this fund since April 2007. As evident from the last three years, the fund’s performance has managed to beat the category returns with a decent margin. Thus looking at the fund’s returns and its portfolio, we advise our readers to make it part of their investments.[PAGE BREAK]

Fidelity Tax Advantage

This is a fund that is aptly suitable for those investors who do not want their blood pressure to fluctuate with the stock market. The portfolio of the Fidelity Tax Advantage fund has a beta of just 0.88 compared to the category average of 0.97. Beta is the rate at which a portfolio is likely to fluctuate in line with the broader market. Even the Sharpe ratio that measures the risk adjusted returns at 0.21 is among the top three in the category and the highest among the selected funds. But a lower volatility does not affect the performance of the fund and the alpha that measures the excess return of the fund relative to the return of the benchmark index is 5.19, which is the highest among the selected funds. The reason for such low volatility comes from the cap on single stock exposure of up to four per cent. This however has been done away with lately. In addition to this, investment allocation in predominantly large cap stocks helped this fund limit its volatility. This even helped the fund contain the losses during the market fall of 2008. The fund maintains a buy and hold strategy following a bottomup stock picking approach.

At the end of October 2010, large cap stocks constituted almost 76 per cent of the fund’s equity portfolio. It held a highly diversified portfolio of 64 stocks with the top ten stocks accounting for 38.37 per cent of its net assets. The fund’s top three sectors namely financial, energy and healthcare constituted almost 48.71 per cent of the net asset. It is the heavy tilt towards the banking and financial services sector where 26.23 per cent of net assets were deployed that has helped it to outperform the category by 250 basis points in the last six months. But in the last few months, the fund has reduced its exposure to this space and trimmed its position in Axis Bank, HDFC Bank and SBI but increased it in ICICI Bank. This timely exit from these stocks might help the fund to strengthen its position in terms of returns going forward.

The fund is managed by Sandeep Kothari since July 2006 which ensures stability and consistency in the funds management and performance. At Fidelity, Sandeep also manages three other equity funds namely Equity, India Growth and International Opportunities. All these funds have managed to beat its category performance by decent margins. Thus, a risk-averse investor may find it a good option to be included in his portfolio.

ICICI Prudential Tax Plan

All men make mistakes but only the wise learn from them, said Winston Churchil. The ICICI Prudential Tax Plan is a fund that has learnt from its past mistakes and it has helped it make its way up in the list of best performing ELSS’. A fund that underperformed the market for three consecutive years from 2006 to 2008 has bounced back with a vengeance in the following two years. This is clearly evident from the returns posted by the fund. Over a five year period, the fund posted a compounded annual return of 14.84 per cent that was marginally higher than the category return of 14.13 per cent. But when we compare the return for a shorter time period (a year or three years), it has clearly outperformed the category returns by a huge margin. For example, in the last three years, the fund has outperformed the category returns by 706 basis points.[PAGE BREAK]

One of the reasons why the fund underperformed during the earlier years was due to its high exposure to mid cap stocks that got thrashed in 2008. But later, a higher allocation towards medium and large cap stocks helped the fund earn good returns. Large cap stocks are the first to recover when the market rebounds after a sharp fall. What also helped the fund perform better is its deployment of cash during the falling market in 2008. However with the improvement in the broader economic condition both on the domestic as well as the international front, the fund seems to be taking aggressive market cap bets. More than 40 per cent of its equity portfolio is now invested in mid and small cap growth stocks.

When it comes to the investing style, the fund normally follows a growth style of investing and invests in large and mid cap stocks. In November 2010, the funds sectoral portfolio seemed concentrated around three sectors namely financial, energy and engineering. All these put together constituted about 44.71 per cent of the total assets of the fund. While a total of 62 stocks in its portfolio make it quite a diversified one, the top ten holdings constitute 43 per cent of the total assets. It held 4.5 per cent of the funds total assets in cash and equivalents.

Sankaran Naren who is the CIO – Equity of ICICI Prudential AMC has been successfully managing this fund since October 2005. Currently Naren manages four other equity funds namely Discovery Fund, Infrastructure Fund and Indo Asia Equity Fund and all these funds have a good long term track record. Taking into account the performance of the fund manager and the compelling portfolio, we will advice aggressive individuals to make it a part of their investments.

Franklin India Tax Shield

Launched in April 1999, the Franklin India Tax Shield fund is amongst the oldest of the six selected funds. What is remarkable about this fund is that throughout its existence it has consistently outperformed the benchmark index. With a 10 year return of 24.14 per cent and 30.17 per cent since its inception, the fund has managed to perform well in both rising as well as falling markets. In 2008, when equity markets fell on the back of the global financial crisis, this fund saw a dip of just 49.22 per cent against an average category loss of 51.8 per cent. Even in 2009, it outperformed the broader market. This is probably one of the reasons why the fund has seen its assets under management swell from from Rs 376 crore in 2008 to Rs 881.2 crore currently.

This fund is largely oriented towards a growth style of investing and is more inclined towards large cap stocks. However it does go for value picks such as engineering companies like Crompton Greaves and Siemens which find a place in its portfolio. The fund is well-diversified with its top 10 holdings accounting for about 47.75 per cent of its total portfolio. Like most other schemes, its top three sectoral allocations include financial stocks[PAGE BREAK]

which account for 19.40 per cent of its total portfolio apart from energy and engineering. It has a mix of both private and public sector banks like ICICI Bank, Kotak Mahindra Bank, SBI and PNB in its holdings. But recently the fund has booked profits in private sector banking stocks and has increased its exposure to public sector banks. What is interesting is that the fund has increased its exposure to the beleaguered telecom sector with Bharti Airtel, which currently constitutes 7.21 per cent of its total portfolio and is apparently the fund’s largest holding. Is it a good contrarian pick? We will surely watch that closely. The fund manager abstains from maintaining large cash positions and is currently holding less than five per cent in cash.

Managed by Anand Radhakrishnan since April 2007, the fund has performed really well under him. Other funds managed by the same fund manager are Franklin India Bluechip Fund, Franklin India Infotech Fund, Franklin India Pharma Fund and the equity portfolio of all Hybrid Funds. Considering the consistent performance of the fund, we suggest every investor should make it a part of their portfolio.

Religare Tax Plan

The Religare Tax Plan fund that has barely completed a little over three years happens to be the youngest among the six funds selected. Plus it has the lowest assets base. Its assets under management were just about Rs 109 crore as on December 31, 2010. But when it comes to performance, this fund clearly stands ahead of many established and much older names in this category. Launched in December 2006, the fund has managed to beat the category returns on a consistent basis outdoing the average category by 386 and 565 basis points in one and three years respectively. The fund has returned 16.6 per cent since inception. This means that Rs 100 invested in the fund since its inception would have grown to Rs 184 today .However in a shorter time period (during the last three and six months), the fund has marginally underperformed the category returns.

This fund generally uses a bottom-up strategy for stock picking and has an investment strategy that is skewed towards growth stocks with large market capitalization. Currently these constitute 62.11 per cent of the fund’s total assets and it is probably one of the reasons why the fund was able to withstand the downfall in 2008 in a better way compared to the benchmark. The fund’s NAV dropped by about 49 per cent during 2008 compared to an average 56 per cent fall witnessed by the other tax saving schemes. Its objective is to invest in a well-researched portfolio, consisting of around 20 - 50 stocks. However it seems to be moving away from its mandate and has always had more than 50 stocks in its portfolio. This however makes the fund’s portfolio quite diversified with a larger number of stocks in it. The top ten stocks accounted for 37.13 per cent of the fund’s net assets while the top three sectors that include financial, energy and FMCG together accounted for nearly 42.41 per cent of the net assets.

The last churning of the portfolio indicates that the fund manager is currently betting on selective large cap private sector banks and reducing exposure to the oil and gas sector. The fund has even lowered its cash levels to 5.33 per cent from 7.11 per cent during the preceding month. This move can help further portfolio[PAGE BREAK]

gains if oil prices keep marching northwards. Thus, looking at the fund’s portfolio and its recent performance only a limited exposure is advised for aggressive investors.

Reliance Tax Saver (ELSS) Fund

This is a fund that comes from India’s largest fund house and therefore it is no surprise that it has the largest assets under management amongst the selected funds. The total AUM of the fund is Rs 2,392 crore as at December 31, 2010. Since its inception in August 2005, this fund has managed to provide an annualized return of 16.34 per cent. It has managed to beat the category returns in a longer time horizon whether it is on a five year basis or on a one year basis. But in the last one month and three months, the fund has underperformed its category. The reason for this might be a higher exposure to the financial sec-tor especially to banking stocks like SBI and ICICI Bank that have witnessed some pressure over the last few months. Going forward we feel that the correction in these stocks has been done with. Once they start their upward move, it will help the fund in outperforming the broader market. Since its inception, the fund has been managed by Ashwani Kumar who also has Reliance Vision, Equity Advantage, Natural Resources and Monthly Income Plan under his purview. What is noteworthy is that all these funds have managed to outperform the category returns.
The fund is a predominantly medium-cap biased one that follows the investment style tilted towards growth companies. It has a very concentrated portfolio. At the end of September 2010, the fund had 38 stocks in its portfolio wherein the top 10 stocks accounted for 38 per cent of its net assets. Like other funds in this category, this one too holds a lower level of cash - 5.5 per cent of the total assets. In terms of sector exposure, financial, engineering and automobiles together accounted for 43.1 per cent of its net assets. More than 53 per cent of its portfolio consisted of mid and small cap stocks while high-beta sectors like realty and infrastructure accounted for only a marginal part of its net assets. This type of fund is more suited to aggressive investors since the portfolio is more skewed towards mid and small cap stocks.