We are in the last leg of the tax-planning season and investing in tax-saving funds (ELSS) is high on most risk-taking investors' 'to-do' lists. At Personalfn, we have always maintained that investing for the purpose of tax-saving is no different from regular investing. Hence the principle of investing in line with one's risk appetite is equally relevant while making tax-saving investments as well. Tax-saving funds offer risk-taking investors the opportunity to invest in line with their risk profiles, while conducting the tax-saving exercise.
More importantly, the 3-Yr lock-in period furthers the cause of long-term investing. Theoretically, the fund manager can invest from a long-term perspective which is pertinent in the case of equity investments. This means he can be indifferent to short-term market occurrences and other factors like intermittent cash flows that can adversely affect a fund manager who is managing an open-ended fund.
We decided to find out if this hypothesis is accurate? In other words, does the 3-Yr lock-in really aid in making long-term investments and is the impact reflected on the net asset value (NAV) appreciation front?
To test the utility of the lock-in, we compared the performances of top-performing tax-saving funds (over a 3-Yr period) with diversified equity funds from the same fund house. To make the comparison apt, diversified equity funds and tax-saving funds with similar investment styles were chosen. For example, a tax-saving fund that invests in "value" stocks was compared with a value fund from the same fund house. Similarly, a tax-saving fund with a bias for large cap stocks was compared with a large cap diversified equity fund from the fund house.
Given the 3-Yr lock-in period, only funds (tax-saving and diversified equity) with a track record of at least 3 years were chosen for purpose of the study. In cases where tax-saving funds don't have a "defined" investment style or a diversified equity fund with a similar investment style is absent, the fund house's flagship equity fund was chosen for the purpose of comparison.
Tax-saving funds vs. Diversified equity funds
| Particulars | NAV (Rs) | 3-Yr | 5-Yr |
| SBI Mutual Fund (Outperformer) | |||
| Magnum Tax Gain | 41.74 | 62.9% | 55.8% |
| Magnum Multiplier Plus | 49.37 | 47.8% | 43.4% |
| HDFC Mutual Fund (Outperformer) | |||
| HDFC TaxSaver | 130.97 | 47.3% | 46.1% |
| HDFC Equity | 139.39 | 39.1% | 44.4% |
| Sundaram Mutual Fund (Outperformer) | |||
| Sundaram Tax Saver | 25.42 | 45.7% | 41.7% |
| Sundaram Growth | 61.44 | 32.3% | 37.4% |
| PruICICI Mutual Fund (Underperformer) | |||
| PruICICI Tax Plan | 81.34 | 45.3% | 43.9% |
| PruICICI Dynamic Plan | 61.80 | 47.0% | - |
| Principal Mutual Fund (Outperformer) | |||
| Principal Tax Savings | 71.43 | 39.7% | 41.0% |
| Principal Resurgent India | 69.16 | 27.8% | 45.1% |
| HDFC Mutual Fund (Outperformer) | |||
| HDFC LT Advantage | 84.64 | 39.2% | 49.2% |
| HDFC Capital Builder | 58.26 | 36.5% | 40.7% |
| Birla Sun Life Mutual Fund (Underperformer) | |||
| Birla Equity Plan | 53.05 | 35.9% | 45.8% |
| Birla Sun Life Equity | 169.13 | 44.6% | 44.3% |
| Canbank Mutual Fund (Outperformer) | |||
| Canequity Tax Saver | 20.59 | 31.3% | 26.5% |
| Canequity Diversified | 27.75 | 28.2% | - |
| Franklin Templeton Mutual Fund (Outperformer) | |||
| Franklin India Taxshield | 118.27 | 31.0% | 36.0% |
| Franklin India Bluechip | 120.40 | 30.9% | 39.1% |
| Principal Mutual Fund (Underperformer) | |||
| Principal Personal Tax | 119.52 | 30.2% | 32.9% |
| Principal Growth | 45.58 | 34.1% | 35.7% |
The results are quite interesting. Of the 10 diversified equity funds chosen, only 3 have managed to outscore tax-saving peers from their respective fund houses. In other cases, tax-saving funds have stolen a march over diversified equity funds. The 3-Yr lock-in has evidently aided tax-saving funds on the NAV appreciation front.
Let's not forget that there is more to tax-saving funds i.e. the tax-benefit. Investments in tax-saving funds upto Rs 100,000 are eligible for deduction from gross total income under Section 80C of the Income Tax Act. The tax benefit should also be factored in while computing the returns to arrive at an accurate picture. Assuming that the investor falls in the highest tax bracket, the returns would be as follows:
Tax-saving funds: Post Section 80C benefits
| Tax-saving Funds | NAV (Rs) | 3-Yr | Tax-adjusted Returns |
| Magnum Tax Gain | 41.74 | 62.9% | 84.2% |
| HDFC TaxSaver | 130.97 | 47.3% | 66.6% |
| Sundaram Tax Saver | 25.42 | 45.7% | 64.8% |
| PruICICI Tax Plan | 81.34 | 45.3% | 64.3% |
| Principal Tax Savings | 71.43 | 39.7% | 58.0% |
| HDFC LT Advantage | 84.64 | 39.2% | 57.5% |
| Birla Equity Plan | 53.05 | 35.9% | 53.7% |
| Canequity Tax Saver | 20.59 | 31.3% | 48.5% |
| Franklin India Taxshield | 118.27 | 31.0% | 48.2% |
| Principal Personal Tax | 119.52 | 30.2% | 47.3% |
The performance of tax-saving funds seems even more impressive once the tax benefits have been factored in. More importantly, every tax-saving fund outscores its diversified equity fund peer. It can be safely concluded that the 3-Yr lock-in coupled with the tax benefits have the potential to make investments in tax-saving funds more lucrative vis-à-vis comparable diversified equity funds.
This in turn makes an interesting case for tax-saving funds as "pure" investment propositions i.e. even beyond a Section 80C investment. Of course, the performance of the tax-saving fund on risk parameters (volatility control and risk-adjusted return), among others also needs to be considered.
So the next time, you as a risk-taking investor decide to invest in a tax-saving fund, ensure that you evaluate the investment from the right perspective.
By Personalfn.com, a financial planning initiative. It can be reached at info@personalfn.com. Personalfn.com also publishes a free-to-download financial planning guide, Money Simplified. To get a copy of the latest issue - How ULIPs fit in - please click here.
