Equity-linked schemes: Start early to save tax, create wealth

Jiju Vidyadharan

We humans are masters of procrastination and victims of inertia. What would logically make sense “now” is comfortably pushed to the back burner. Take the case of tax planning – almost always a year-end mad rush to invest; and almost always in fixed income tax-saving instruments. Why do we not start early and invest as per our risk-return profile when we have a vast investment universe to choose from? These schemes help not only save tax but also create wealth over a long term. But start early.

Equity-linked Savings Scheme

• Tax-saving scheme that predominantly invests in equity securities
• Professionally managed by fund managers with experience and backed by research
• Diversified portfolio across sectors and market capitalization
• Market-linked returns offer long-term wealth creation opportunity
• The equity asset class (represented by S&P BSE Sensex) has given 16% CAGR, on average, for 10 years on a daily rolling basis since its inception in 1979.
• In contrast, traditional tax-saving avenues such as public provident fund or PPF, tax saving bank fixed deposits or FDs and national savings certificate or NSC offer fixed returns, which may not be satisfactory after inflation is factored in.
• ELSS has the lowest lock-in period of three years compared with other popular traditional avenues of Section 80C such as PPF (15 years), FDs (five years) and NSC (five years).
• Long investment horizon of over 7-10 years increases probability of higher risk-adjusted returns for investors
• Withdrawals from ELSS are tax-free as the long-term capital gains tax on equity funds is nil and dividend income is tax-free
• Flexibility to invest on a monthly basis through systematic investment plans (SIPs)
• Minimum investments as low as Rs 500 per month
• Reduces market volatility and averages out the cost for investor
• Investments are subject to market risk and, hence, investors must consider age and risk appetite
• Lowest lock-in period, but invest over long term to derive optimum benefits

Although ELSS enjoys the lowest lock-in period and investors can withdraw after three years, the underlying asset these schemes invest in — equity — is known to be volatile in the short term. CRISIL’s rolling returns analysis shows that even though ELSS (represented by CRISIL-AMFI ELSS Fund performance index) have returned 24% CAGR [1], on average, for a three-year holding period, investors can face the risk of short-term volatility. For instance, the rolling three-year period analysis shows that investors can face capital erosion (minimum returns of -11%) and high volatility (represented by standard deviation) of 20%. These risks reduce as investors increase their investment horizon to the long term, thus deriving optimum benefits.

For instance, ELSS have given 10-year rolling returns of 19% CAGR, on average, with volatility reduced to 6% and minimum returns of 10%.

This is still a fail-safe higher yield versus long-term inflation of around 7% [2] and 8% [3] by traditional instruments. Also, this is in sync with a young profile and long-term horizon for aggressive investors.

Rising popularity, albeit a few concerns

ELSS has been gaining popularity over the years if the meteoric rise in assets under management is any indication. The category currently manages Rs 70,087 crore as of August 2017, up 18% on an annualized basis over the past decade and compared with 16% growth for industry over the same period. One should invest only after considering his/her risk profile and conducting proper due diligence. Investors can refer to independent mutual fund rankings provided at www.crisil.com as a guide to identify top ELSS performers.

[1] Average returns of CRISIL-AMFI ELSS Fund performance index calculated on daily rolling basis since inception (June 2001)

[2] Average of annual CPI (Industrial Workers) inflation since June 2001

[3] Represented by average returns (annualised) for 10-year holding period of 3-year FD index on a daily rolling basis since June 2001

The writer is Senior Director, Funds & Fixed Income, CRISIL. The views expressed in this article are his own