Best ELSS for Tax Planning in 2020

The New Year is just around the corner. If one of your goals for the New Year is to protect your wealth from taxes, have you considered investing in Equity-Linked Saving Scheme (ELSS), an equity-oriented tax saving mutual fund?

Best ELSS for Tax Planning in 2020
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ELSS, like all other equity mutual fund schemes, are managed by professional fund managers. They invest with an aim to make higher gains for their investors. So if you invest in the right schemes, you can gain much higher returns than you can probably expect from a tax saver bank fixed deposit, PPF account, NSC or any other tax-saving schemes.

[Read: Everything You Need To Know About Tax Planning]

What is ELSS?

ELSS is an open-ended equity scheme which comes with a lock-in period of 3 years. Investment in ELSS is eligible for a deduction under Section 80C of the Income Tax Act up to Rs 1.5 lakh. If you invest via the systematic investment plan (SIP) route, each instalment is subject to a lock-in period of 3 years.

These funds have the flexibility to invest across market capitalisation. Accordingly, most ELSS hold a diversified portfolio and usually are market cap and sector agnostic. ELSS may follow the growth style or value style of investing or a combination of both.

ELSS have the lowest lock-in period compared to other tax-saving instruments. National Savings Certificate (NSC) and tax-saving FD both have a lock-in period of 5 years; Public Provident Fund (PPF) is locked-in for 15 years while National Pension System (NPS) is locked-in till the age of 60 years.

[Read: 4 Tax-Saving Investment Options for Risk Takers]

So, if you are looking for tax benefits along with higher return potential, but do not want to commit your money for a very long period, say 5 to 15 years or more, then ELSS is an investment option you must consider.

When compared to other popular tax-saving instruments such as tax saving FD and PPF, ELSS has the potential to reap higher returns for its investors which makes it a worthy avenue for tax efficiency and long term wealth creation.

Graph: Placement of ELSS on risk-return spectrum

Graph: Placement of ELSS on risk-return spectrum
Note: For illustrative purpose only
(Source: PersonalFN Research)

In terms of risk-return profile, ELSS carries moderately high risk. Since it is an equity-oriented scheme, the returns are not fixed and will depend on how the market performs. Thus, invest in ELSS only if you can bear short-term volatility in the equity market, hold a high-risk appetite, and have an investment time horizon of at least 3 years.

Bear in mind, investments in equities take time to grow and generate meaningful returns. This means that there can be short-term underperformance. As a result, you may have to hold on to your investment beyond the mandatory lock-in period.

Table: Top performing ELSS funds

Absolute (%) CAGR (%)
Scheme Name 1 Year 3 Years 5 Years
Mirae Asset Tax Saver Fund 17.41 20.58 NA
Axis Long Term Equity Fund 17.81 19.81 13.17
JM Tax Gain Fund 17.51 18.16 12.10
BOI AXA Tax Advantage Fund 18.45 17.55 10.78
Tata India Tax Savings Fund 17.19 17.49 13.93
LIC MF Tax Plan 14.79 17.22 10.22
Motilal Oswal Long Term Equity Fund 16.29 17.13 NA
Canara Rob Equity Tax Saver Fund 13.68 16.44 9.86
Invesco India Tax Plan 12.25 16.27 12.19
BNP Paribas Long Term Equity Fund 17.39 16.20 9.70
S&P BSE 200 - TRI 12.03 15.52 9.98
S&P BSE 500 - TRI 10.55 14.73 9.63
S&P BSE SENSEX - TRI 17.44 18.04 10.24
Data as on December 27, 2019
(Source: ACE MF)
*Please note, this table only represents the best performing ELSS Funds based solely on past returns and is NOT a recommendation. Mutual Fund investments are subject to market risks. Read all scheme related documents carefully. Past performance is not an indicator for future returns. The percentage returns shown are only for an indicative purpose. Speak to your investment advisor for further assistance before investing.

A number of ELSS have successfully created wealth for investors outperforming their respective benchmark indices and category average across time frames. Some of the best performing scheme as per PersonalFN that have proved its worth in the past on both quantitative and qualitative parameters are Axis Long Term Equity Fund, Canara Robeco Equity Tax Saver Fund, Mirae Asset Tax Saver Fund, Invesco India Tax Plan, and Kotak Tax Saver Scheme.

Some of the other decent performers are:

A long-term investment in ELSS is a more prudent choice as compared to other fixed-income products. But as with all market-linked investments, there is a risk.

Often investors tend to give in to their behavioural biases and end up making mistakes. PersonalFN highlights some of the common mistakes made when investing in ELSS.

7 Mistake To Avoid

Here’s how to pick the best ELSS in 2020…

Quantitative Parameters:

  1. Performance and risk analysis

    Analyse if the fund has shown consistency in performance across various market periods with decent risk-adjusted returns.

    Under this, you need to rank the fund based on quantitative parameters like rolling returns across short-term and long-term periods, such as a 1-year, 3-year, and 5-year timeframe, and on risk-reward ratios like Sharpe Ratio, Sortino Ratio, and Standard Deviation over a 3-year period.

  2. Performance across market cycles

    You need to ensure that the fund has the ability to perform consistently well across multiple market cycles. Therefore, compare the performance of all the available ELSS vis-a-vis their benchmark index as well as category peers across bull phases and bear market phases.

    A fund that performs well on both sides of the market should rank higher on the list.

Qualitative Parameters

  1. Portfolio Quality

    Adequate Diversification - The scheme should not hold a highly concentrated portfolio. It should have a well-diversified portfolio and the exposure to the top-10 holdings should be ideally under 50%.

    Low Churn - Engaging in high churning can result in higher cost impacting the overall return of the scheme. Therefore, you also need to consider the portfolio turnover ratio and expenses, and penalise funds involved in high churning, i.e. those funds with a turnover ratio of more than 100%.

  2. Quality of Fund Management

    You must consider the fund manager's experience, workload, and the consistency of the fund house. Therefore, assess the following criteria:

    The fund manager's work experience - He/she should have a decent experience in investment research and fund management, ideally over a decade.

    The number of schemes managed - A fund manager usually manages multiple schemes. Thus, you need to check if the fund manager is burdened with managing a large number of schemes. If he is managing more than five open-ended funds, it should raise a red flag.

    The efficiency of the fund house in managing your money - Research about the fund house's performance across schemes; find out if only a few selected schemes are doing well. A fund house that performs well across the board is an indication of sound investment processes and risk management techniques in place.

    Yes, we know that the above list is a lot for an average investor to look at. It involves a lot of number crunching and much of the data is not easily available in one place. But if you do need to narrow down on the top funds, these factors are of utmost importance.

Watch this short video on selecting mutual fund schemes:

Watch this short video on selecting mutual fund schemes

The outlook for 2020

Most ELSS invest across market capitalisation. Therefore, they are likely to benefit from the expected comeback in the mid caps and small caps. However, one cannot rule out volatility in the near term.

If you are willing to assume high risk, earn market-linked returns, and have an investment time horizon of at least 3 years; opt for ELSS for tax planning in 2020.

ELSS, as a category, has showcased impressive record over the long term, generating alpha over the benchmark indices. That said, choose an ELSS prudently because if you decide on a not-so-worthy fund, you will have to bear the cost of underperformance for the entire lock-in period.

If you prudently select the best ELSS, it can prove to be a rewarding experience in the long run. Ideally, if the ELSS you have invested in performs well, it would be sensible to stay invested even beyond the lock-in period of three years to maximise the return potential and accomplish the envisioned financial goals.

If you are not sure about how to align these schemes with your tax planning or financial goals, do consult your investment consultant/advisor.

At PersonalFN, we select and recommend mutual funds on quantitative and qualitative parameters using our S.M.A.R.T Score Matrix:

  • S - Systems and Processes

  • M - Market Cycle Performance

  • A - Asset Management Style

  • R - Risk-Reward Ratios

  • T - Performance Track Record

Happy Investing and Happy Tax Planning!

Editor's Note: 

If you wish to select worthy mutual fund schemes, I recommend you subscribe to PersonalFN's unbiased premium research service, FundSelect.

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Author: Divya Grover