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CRISIL FUND INSIGHTS Monthly funds newsletter from CRISIL Research Volume – 57 January 2016

Investment thoughts

This tax season, grow your wealth with ELSS

With the financial year nearing closure, investing in tax saving instruments is high on everyone’s priority list – the vanilla options being five-year fixed deposits, the public provident fund (PPF), national savings certificates (NSC) etc. Agreed, these instruments promise safety and stability. However, the large youth population in India needs avenues that would complement their long investment horizon more commensurately. Equity is one such asset class that can deliver higher returns. Equity-linked savings schemes (ELSS) offered by domestic mutual funds allows retail investors to seek exposure to equity and save on their tax outgo, under Section 80C of the Income Tax Act.

ELSS – at a glance ■

Tax-saving mutual fund scheme that predominantly invests in a diversified portfolio of stocks

Units to be held by investors for at least three years to claim tax rebate

Falls under the exempt exempt-exempt (EEE) category (no capital gain tax and tax-free dividend)

Investments up to Rs 1.5 lakh allowed as deduction under section 80C

Investors can save up to Rs 15,450, Rs 30,900 and Rs 46,350 for tax brackets of 10.3%, 20.6% and 30.9% respectively, for investments of Rs 1.5 lakh.

Possible to invest regularly via systematic investment plans (SIPs) with as low as Rs 500 per month.

A longer investment horizon will ensure higher risk-adjusted return

Investments are subject to market risk and hence, investors must consider investment goals, time horizon, age and risk appetite

ELSS v/s traditional instruments - Lowest holding period, superior average returns Among tax saving instruments available under Section 80C, ELSS funds have the lowest holding period i.e. three years, while CRISIL’s analysis - represented by CRISIL – AMFI ELSS Fund Performance index - shows these funds have given an average 28% CAGR return over a 3-year rolling period since June 2001. This is more than twice the rate of return offered by traditional debt instruments (8-10%).

Widen investment horizon to reduce risks While ELSS funds have given an average three-year holding return of 28% (compounded), there is a flipside. The minimum return over this period was -10%, which spelt capital losses. Hence, investors should bear in mind, risks that come to the fore if they have a short-term horizon. Yes, this can this be offset – by stretching the investment horizon (see Chart 1). Even with average returns remaining over 20%, over a wider horizon, volatility diminishes gradually and the minimum return increases. Over a 10-year investment horizon, ELSS funds have offered a minimum return of 13%, still a failsafe higher return compared with traditional instruments. Systematic approach to investment Systematic investment plans (SIPs) allow individuals to park funds in ELSS, starting as low as Rs 500 per month, at regular intervals. SIPs will help investors benefit from rupee cost averaging, and thus offset volatility in the equity market. Also, instead of making a huge rush to invest in tax-saving instruments towards the last quarter, SIPs allow investors to spread their investment across the fiscal, starting from April itself. However, investors must note that they can claim tax benefits only if they hold the investments in ELSS for at least three years. For the record, every SIP installment gets locked for three years. Thus, the last SIP of a 1-year ELSS will finish its lock-in period only after another three years i.e., four years from the start of the first SIP.

Summing up

Chart 1: Risk versus return for ELSS 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% 3 year Average returns

5 year

7 year M