The Mutual Fund Show: Best ELSS Schemes For Tax Benefits

Kaustubh Belapurkar: ELSS stands for Equity Linked Savings Schemes that are essentially diversified equity funds that give you a tax break under Section 80C, up to Rs 1.5 lakh for an investment that you can claim a tax break on.

It comes with the three year lock-in (period). Once the money is in there, you can't remove it for three years. That's great because obviously when you think about equity, three years is probably the bare minimum; I would think about five to seven to ten years from an investment perspective.

An ELSS fund is very similar to a Diversified Equity Fund, like flexi-cap funds in which an investor would typically invest in. A lot of ELSS funds would tend to have a reasonable amount invested in large-cap stocks, but there could also be funds that would go down with the small caps. There are various types of funds that are available and some great funds run by great managers.

Here is a brilliant instrument that you can use to not only save tax, but also invest for the long term. What the data shows is that investors are not redeeming their money after three years. They're not trying to flip around. I am glad we are seeing that.

Equities are a long term investing class. We will have ups and downs, like we've seen in recent times. So, I think the investors have understood that this is a great vehicle. There is a three-year lock-in, but I can stay invested for a much longer term. So, I would treat that like any other equity investment fund with a tax break attached to it.

Kaustubh Belapurkar: Obviously, there's a limit of Rs 1.5 lakh under Section 80C. If you have other components that are already contributing towards that, then in that sense, the effectiveness of the tax break would reduce.

It's practically a Diversified Equity Fund. We can’t compare it against an open-ended fund which doesn't have a lock in. There are some implicit benefits of lock-in because the manager has more visibility on the kind of money that’s there for at least three years. They can really put their best ideas and size them up properly, rather than having to worry about keeping the liquidity buffer within the portfolio. There's a greater sort of flexibility for the manager which always helps.

Kaustubh Belapurkar: The only drawback is if there is an urgent need for liquidity in the portfolio, or for whatever unforeseen requirement; if you planned to invest for a longer time, but you need the money for the short term, that's not going to be possible. So, that's the only potential drawback. But, otherwise, it’s at par with other Diversified Equity Funds. The cherry on the top is the tax aspect.

The one thing that investors need to keep in mind because it's a diverse category is that there will be managers who will be more focused towards large caps or there will be managers who buy more of mid and small caps.

Investors need to keep in mind when they're picking an ELSS how does the fund fit within the context of their portfolio. For instance, managers who had a large proportion of mid and small caps have obviously done potentially better in the last year or two, given the run up of those counters. Optically, the returns for some might look great, but you have to understand the construct of the portfolio or the way it would be, and does it really meet your goals or fit into your portfolio or not.

Kaustubh Belapurkar: One of our favourites is the Mirae Asset Tax Saver Fund managed by Neelesh Surana, who is a brilliant manager. He's been running this strategy since inception, and doing an exceptional job.

When I think about the way the strategy has been run, what are the underpinnings of the strategy – the focus is towards buying quality growth companies, but not overpaying in terms of valuation. That's been Neelesh’s underlying focus where he talks about the margin of safety that ‘I want to buy good companies which are offering good growth, but I want to have that margin of safety built into the price that I enter at’.

So, that's what he has looked to apply, and we've consistently seen him do that in the portfolio. Obviously, when you look at the returns, it has worked brilliantly across market cycles.

The other thing that he does right is that he is benchmark-aware as a manager. He won't really say that I'm going to take very large sectoral bets. There will be sectoral deviation but within a limit.

He sees fundamentally good stocks at attractive valuations, growth at a reasonable price, and value. He's got a large cap bias, maybe not as much as some of the others that we'll talk about later, but in the range of 60 to 75, which is a pretty reasonable amount of large cap. I think it's a diversified portfolio. So, it's been running with a consistent mandate. Identifying some of the undervalued opportunities has worked for the strategy.

Kaustubh Belapurkar: No, I wouldn't think so. My only concern is that investors should know that returns should always be taken with a pinch of salt. One thing to acknowledge is that every style will go through a period of underperformance.

There will be a period of the market when your style is not working. What's important is that the managers stick to their style and investors stay invested. Because it's not working today, it doesn't mean that it’s not going to work tomorrow. That's just a function of the market.

Be ready for periods where maybe some other funds are doing better relatively; that is par for the course.

Kaustubh Belapurkar: The rating system that we described is basically a qualitative analysis.

We think about the people who are managing the team – not just the manager, but also the other investment analysts – the investment process, if we think it's been consistently run and can it help generate alpha over a period of time, and do we see enough proof of the fund manager sticking to their guns over a period of time, is enough value being added...

Gold, silver and bronze are all positive ratings. It is just normally what we assign as a probability, that we think this fund probably has a higher chance of continuing to outperform the benchmark and its peer group over a long-term risk adjusted basis.

But both are positive ratings; both are strategies that we would like – just the level of conviction could vary, broadly on the rating system.

How does this fund stack up and what's different? This fund is again managed by a very experienced manager Jinesh Gopani. It's a fund that followed a constant investment philosophy.

How's it different from the Mirae Fund? He's looking at quality growth companies, but the mandate is that ‘I don't worry so much about valuations, because I think the growth will pay for the valuation’. So, if I'm buying an expensive stock today, I think the growth will compensate for that. That's really the underpinning of the way Jinesh’s management strategy is for a very long time.

He has spoken about performance cyclicality. If you see 2021 and year till date has been relatively poorer for this fund versus its peer group. But the years of 2018-2020 were brilliant for this fund. Why is that? Because of the focus towards high growth, high quality stocks. That was a segment of the market that did really well between 2018 to 2020, and he stuck to his guns and it worked beautifully.

2021 is the more cyclical part of the market, which has seen rallies which obviously is not in favour of the style, but that’s perfectly understandable.

When you talk to Jinesh, a couple of things beyond this high quality, high growth style is he clearly wants to build a more focused, concentrated portfolio. It is slightly different from the Mirae one which would be more diversified, and typically between 30 and 40 stocks.

He would look to avoid some of those, he typically looks to avoid PSUs or heavily regulated companies or cyclical earning companies. That doesn't really fit into his investment framework and he's kind of applied that way consistently.

In a way, they are slightly different portfolios. There's obviously a little bit of overlap, given that both are quality, growth managers. But the one thing that Jinesh has done beautifully is that he stuck to his conviction on that. We've seen periods of underperformance even in 2016 when we had the last cyclical metal rally, where he was still holding to high growth. It did not work, but then obviously, we have seen the performance that has been aided by the superior process which we think Jinesh and the Axis team follows.

So, that's broadly why we have a good amount of conviction. I would say don't be perturbed about why this fund is underperforming over the recent term. It's just a function of the market side.

Kaustubh Belapurkar: This is another interesting sort of strategy and different from the other two. Rohit Singhania manages this strategy and he’s again a very experienced manager.

In terms of how he's looking to construct the portfolio, he's got a much more fluid approach, he doesn't really worry too much about what the benchmark is. He doesn't have any restrictions in terms of sectors or stocks, underweight or overweight. He has a fluid strategy. There will be a core part of the portfolio, there will be a tactical part where he thinks that ‘it’s super cheap, I will get in’.

The other two are ‘buy and hold’ sort of strategies. Rohit would tend to be a little on top of switching his positions. He goes down the valuation curve; he will look to identify companies, which probably are either going through a little bit of a stretch (I wouldn’t say distress), but basically businesses which can start getting to a rising return on equity sort of environment and the cash flows are improving. It’s a kind of early identification of those sort of sectors or ideas that he would do.

Again, from a capitalisation perspective, he is slightly different because he will tend to hold about one third of his portfolio in small and mid caps. So, in that sense it’s probably higher than where the earlier two funds were, and it's a diversified portfolio.

But some of his stock picks or sector picks worked beautifully, especially the metal stocks. Now he has exited some of his positions and booked significant profits. That's the element that I was referring to – he can be fluid and he executed that really well.

The only thing obviously with a strategy like this can come increased volatility. So volatility of the market can be a little higher for this portfolio – it can move up greater in the market or fall more than the market. But that’s purely a construct of the way the portfolio is being designed. I think he’s a great manager with a slightly differentiated process.

The reason why I bring up different styles is because a lot of times investors don't tend to look at the underlying construct of the portfolio – are they too focused towards capitalisation or style. A lot of investors went into purely growth style funds in the last couple of years given how well it had done. Everyone thought that this is a space they want to be in. Value or cyclical part of the market has worked in the last one year.

These are various types of funds that can allow you to mix up the composition. Look at what you already hold, and then see if you're overexposed to growth or value. You can afford to choose a fund that fits into your portfolio.

Kaustubh Belapurkar: A couple of things have happened. This fund has seen a change in manager. Anand Radhakrishnan used to manage this fund for the longest time, up to about 2016, and then Laxmi Kant was the manager. And after Laxmi Kant moved on from the company, Anand has taken back the strategy of the fund.

What hasn't changed is the core investing philosophy of the strategy. There could be some changes in the margin but the team at Franklin are great investment managers.

What they've done and the style of this has been tilted towards value. Anand will look to buy that segment of the market – which is going through elements of stress, or valuations are attractive but fundamentals are still strong.

The performance of this fund in the growth phase around 2018-2020 was relatively much worse off than the others. But kudos to Laxmi Kant and Anand who held onto their convictions, and we saw the turnaround in 2021 because they didn't try to chase the market. They stuck to what their investing style was, more value-focused.

Anand as a manager and the stickiness of the investment process even through tough times gives us conviction. If you're largely exposed to growth funds or style funds in your portfolio, here comes a very good value manager.

Kaustubh Belapurkar: I think that's the easiest thing. If you haven't done so already, set it up on a recurring basis now for the next year or two, because markets are a strange animal that can swing. And you don't want to be waiting till the end, hoping that the market will fall or whatever. So, just stagger it out; it works best.

This is an investment that you want to make to save tax, and obviously as an investment vehicle. So, go ahead and set up an SIP today.

And let's continue with that at least for a few years so you have reasonable visibility that you're buying on a staggered basis, rather than time the market.