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Business News/ Money / Personal Finance/  How to choose the right ELSS funds? 4 key parameters to know
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How to choose the right ELSS funds? 4 key parameters to know

With a lock-in period of three years, it is indispensable that you choose the right ELSS fund with all considerations in mind

One of the key things to consider is returns on the fund. One can look at one year or three-year fund returnsPremium
One of the key things to consider is returns on the fund. One can look at one year or three-year fund returns

Equity linked saving schemes (ELSS) are one of the most prudent investment options recommended by financial advisors. Some experts speak about the high returns they offer by virtue of their exposure to equity, whereas others talk about their innate ability to save tax.

However, one of the challenges which small investors face is to decide which ELSS fund can one invest into. Currently there are three dozen ELSS funds offered by a number of asset management companies. And despite the fundamental similarities, they are like chalk and cheese to each other.

"ELSS funds are suitable for investors who are willing to take risk. Importantly, this is the only instrument with a short lock-in period of just three years. The other fixed income instruments have longer lock-in," says S Sridharan, founder and principal officer, Wealth Ladder Direct.

Here, we explore the key criteria which can be chosen to differentiate between different mutual funds in order to separate the wheat from the chaff.

Look at returns: One of the key things to consider is returns given by the funds. One can look at one year or three-year returns. To prevent the bias of a particular period, one can base his decision on the rolling returns. It's vital to make sure that the fund you choose has given good returns consistently year after year. Be aware of the fact that giving good returns merely for one year could be a blip.

According to the Mutual Fund Screener Dec 2021 data, ELSS funds gave higher returns than large cap funds but lower than mid and small cap in past one and three years. Click here for more details.

Ability to control downsides: ELSS fund should have the ability to contain downsides too. A good ELSS fund, in fact, any good mutual fund for that matter, should defend well in a correction phase. It can be gauged by comparing the funds’ downside protection vis-à-vis market benchmarks and peers. There is another way to see it is via downside capture ratio. A downside capture ratio of lower than 100 means a fund lost less than its benchmark during market correction.

Best performing ELSS funds in past one year

Fund                                                             1-yr-return (%)
Quant Tax Plan                                       37.18
IDFC Tax Advantage (ELSS) Fund              27.81
HDFC Taxsaver Fund                               26.76
Union Long Term Equity                               23.28
Franklin India Taxshield Fund                     21.15
ICICI Prudential Long Term Equity Fund (Tax Saving)          20.90
DSP Tax Saver Fund                                   20.32

(Source: AMFI; direct returns on April 29, 2022)

 

Keep a tab on allocation and style: It’s pertinent to see the how much allocation has been made across the spectrum of market cap distribution. It is a common knowledge that large caps investment is safer when compared to small cap and mid cap. Investing in the mid and small cap stocks is riskier, and expectations of returns are higher, and so is the risk.

Also, it must be seen whether investment style – whether it is value investing or growth investing to judge the likely performance of funds.

Investors can save tax by investing in equity linked saving scheme.
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Investors can save tax by investing in equity linked saving scheme.

Growth style implies a higher investment is being made in higher price-to-earnings multiples for growing firms and these are believed to be more volatile. On the other hand, value investing entails lower price to earnings (P/E) ratio than broader market and are less risky than the market index.

Total expense ratio: An optimum total expense ratio is important to maximise the returns. When the TER is high, it eats into the returns. But it must be understood that large funds are meant to charge lower TER. So, when a fund charges a lower TER, it means the fund is large, which is not a guarantee for high returns. But it can be seen as one of the factors to choose one fund over another.

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Published: 02 May 2022, 03:34 PM IST
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