Equity-linked Savings Schemes (ELSS) or tax-saving funds as they are commonly referred to, offer investors the unique opportunity to invest in a market-linked product and yet claim tax-benefits; unlike conventional tax-saving instruments which are generally of the assured returns variety.
Also these investments have a 3-year lock-in period and how investors benefit from the same is a well-documented fact.
We decided to evaluate how ELSS perform on the expenses front. Expenses towards management and advisory fees, marketing and selling expenses are all charged to the fund.
As a result, they have a direct bearing on the fund's performance; higher expenses translate into lower returns for investors.
For the purpose of our study, we chose top-performing tax-saving funds over a 3-year period and squared them off against leaders in the diversified equity funds segment over the same tenure.
Cost-effective propositions!
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Are the expenses justified?
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The results are proverbial eye-openers. Diversified equity funds have emerged as relatively cost-effective propositions vis-à-vis their counterparts in the ELSS category.
Most funds from the ELSS list have either utilised the 2.50% upper limit on expenses (that can be charged to the fund) or are reasonably close to doing so -- e.g. HDFC Tax Plan (2.50%), Principal Tax Savings Fund (2.50%) and Tata Tax Savings Fund (2.30%).
On the other hand, DSP ML Opportunities Fund (2.50%) is the only fund from the diversified equity funds segment to exhaust the permissible limit.
Rank top-performing tax-saving funds
Tax-saving funds have a 3-year lock-in which ensures that the fund manager has sufficient time at his disposal to make the 'right' investment decisions and wait till they bear fruit.
Investors also judge the attractiveness of the fund over the longer horizon; as a result the fund manager can afford to adopt a rather 'passive' approach while managing the fund.
He is not required to aggressively churn his portfolio and invest in the season's flavour either. However this relatively docile fund management style is not reflected in the expense ratios.
Diversified equity funds on the other hand are constantly under the scanner; the fund manager is expected to deliver at all occasions even over shorter time horizons. Leading equity funds appear to have delivered results and yet managed to be economical in their operations.
The explanation to this disparity might lie in the funds' asset size. Diversified equity funds have significantly larger corpus sizes, which in turn leads to benefits arising from economies of scale.
Tax-saving funds on the other hand have to contend with a lower corpus and possibly the resultant higher expenses.
The higher expenses for tax-saving funds notwithstanding, this segment offers a unique set of advantages that none of its peers can.
However, the next time you conduct a tax-planning exercise, ensure that you look beyond just the returns while selecting a tax-saving fund.
