Why ELSS Still Merits A Place

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Why ELSS Still Merits A Place
Why ELSS Still Merits A Place
Nilanjan Dey - 30 December 2023

This is the last hurrah for tax savings through a medium that seems to have been dealt a body blow, thanks to the growing acceptance of the new tax regime in which it can play a limited role.

Equity-linked savings schemes (ELSS) is a genre that is clearly relegated to the deep end of our mental pool till the year-end signals for tax savings hit our subconscious mind. Yet, despite the very lonely furrow it is currently ploughing, the latest numbers delivered by ELSS, on average, are quite impressive. Their marginalised status notwithstanding, investors need to do a full-scale re-think on their utility.

The concept of ELSS packs an unputdownable medley—the shortest lock-in period (‘shortest’ vis-a-vis other competing tax-saving options), the potential of its all-equity portfolio, and the fact that it allows full exit after a mere three years. No other option— certainly not the administered-rate alternatives offered by the post office —can come anywhere close to the performance logged by the tax-saving funds.

For the record, the returns delivered by the ELSS category over the last three years have been in superlative double digits. That it has been aided by a burgeoning stock market is clearly evident. After all, most tax-saving funds carry diversified portfolios, and their fund managers really do not have to face a great deal of redemption pressure. Indeed, investors need not exit even after the passage of three years (the mandatory period during which their money stays locked-in). Many, in fact, stay invested for longer durations in order to optimise their gains from advancing equities.

The propensity to stay longer than the stipulated period of 36 months has been amply demonstrated in recent quarters by a large section of ELSS investors. A number of them have held on to their units in an attempt to secure considerably higher returns. Redemptions that could have been sought naturally were deferred, financial planners and advisors point out.

The situation, in fact, has actually prompted a section of the market to clamour for a relaxation in norms related to ELSS. Some of the most cogent arguments are based on the following pointers:

1. The scope for tax savings may be extended to reach beyond the rigorous limits (read: `1.50 lakh) set under Section 80C of the Income-tax Act, 1961.

2. A new sub-section may perhaps be drawn up exclusively for ELSS within Section 80C considering the potential of the equity market. This will enable investors to allocate more to a powerful asset class.

3. There will be no need to tweak the new tax regime, which the government has introduced as a reformist measure. The old tax regime may, however, be rendered more accommodative in terms of ELSS allocations. This will allow investors to have a wider and more effective option to consider.

These three reasons furnished by the market together presents a clear solution for those who need to save tax, but are troubled by the stiff Lakshman Rekha drawn by the income tax authorities.

The investment market in India is already being driven by higher average income levels and larger allocations. As financialisation gathers pace, common people take to active investments, and as earnings turn healthier, the need to expand the scope of Section 80C becomes more palpable. Yet, the new tax regime presents quite a different strategy. In sum, it brings little cheer to ELSS investors.

But how does ELSS score over other tax-saving alternatives? At the cost of repetition, let me focus exclusively on performance. Do note that the standard small savings scheme permitted under Section 80C cannot provide more than 8-8.5 per cent return. The likes of insurance premium really do not compare favourably. Insurance relates primarily to risk management. Returns, however, are generated mainly by market-driven alternatives, such as actively-managed tax-saving funds.

While performance actually depends on the skills of the fund manager, ELSS, as a genre is well expected to cover the impact of taxes and inflation. And that is the very least of expectations because investors require a lot more from their fund managers.

Many advisors—admittedly, no performance can ever be guaranteed —expect at least 15-16 per cent from ELSS for their clients. This, of course, has come true in the case of many tax savers in recent times.

Here are a few practical tips, courtesy advisors who hold ELSS in high esteem.

  • Investors must stay well-diversified within the ELSS camp. Thus, allocation to more than one tax saver is recommended in a financial year.
  • Choosing the right product is critical. Therefore, an analytical examination of portfolios is important. Moreover, competing ELSS funds must be weighed against each other on the key risk metrics.
  • Past performance, quite naturally, should not influence choice. Instead, investors should see these funds through prisms such as Sharpe and Treynor. These details are commonly available. A number of digital tools (which may be used for review and analysis) are also accessible easily.
  • Investors need not exit their funds even when the mandatory lock-in is exhausted. A fund that may have advanced handsomely over three years is expected to gain further in the days ahead. When the market is moving ahead, thanks to increasing valuations, unitholders may well remain committed to their funds.

Ultimately, all categories of investors will realise that ELSS is the only unique class of tax efficient instrument that can potentially create considerable wealth. This, in fact, will remain its primary rationale unless the securities regulator tweaks its stance in favour of another version of the category. The market may also welcome variants of the present-day ELSS. Already, there is a case for index-linked, passively-managed tax saving options based on debt instruments. A proposal on a value-added option with a 5-year lock in has also done the rounds.

As overall income levels move northwards, the need to save tax will assume greater proportions. The contemporary Indian, especially one who is not unwilling to take risks, will not like old-school administered-rate alternatives. As we enter the last quarter of fiscal 2024, the pitch for actively managed tax savings will only get stronger. A combination of tax sops, capital appreciation and easy liquidity will improve its appeal. An “earn more, spend more but save as much as possible” strategy will ultimately find its own place under the sun.

By Nilanjan Dey, Director, Wishlist Capital

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