Last Chance ELSS

ELSS =Equity Linked Savings Scheme ,is a special category of mutual funds that invest predominantly in stocks. They are very comparable to diversified equity funds. The only differences between regular diversified equity funds and ELSSs are the 80C tax benefits on investments upto 1 lakh and the lock-in period of 3 years,incidentally the least among all 80C tax-saving avenues. It means that once you invest in an ELSS , you cannot withdraw your investment for a period of 3 yearsHowever,the DTC proposes to phase out the tax breaks on ELSS , so this avenue may be closed in the coming years.But, you can still invest in it this year and get tax breaks.

The best ELSSs have not done too badly during downturns and have given excellent returns in boom times.The reason has been the lock-in period. These funds have not suffered due to large scale redemptions when the market sentiments have tanked.Moreover, fund managers  keep a portion of the mutual fund corpus, around 7-10%, as cash,even in good times, so that they can meet all redemption requests. This cash is invested in very short term debt investments, generating meager returns. This impacts the overall returns of the mutual.Since the fund manager of an ELSS knows that  funds cannot be withdrawn for 3 years, he can invest all the funds in equities and keep less money as cash and provide good returns in the long term.

Personally,I was introduced to ELSSs by my bank manager ,any years ago when I first started earning.He was the one who pointed out that ELSSs score over other tax-saving schemes since it offers tax-free return (long-term capital gains and dividends are totally tax-free as).Also as the investment had a lock in period of only 3 years, by building a 3 step ladder of ELSS I could divert money for other expenses without fear of being unable to take full advantage of s.80C.All I had to do was redeem the oldest deposit and reinvest in an ELSS.Here is a further refinement:The dividend that is invested back in the scheme is considered fresh investment, so this money is further locked in for three years, and this can create an infinite loop.

The mutual fund industry and SEBI have been lobbying for the continuation of ELSS benefits and there is a possiblility that things will continue as they are for ELSSs.Otherwise from next year ELSSs will become regular diversified equity mutual funds. That is: 1. There will be no tax benefits on investing in ELSS funds & 2. There will be no 3 year lock-in period.So this might be the last year to get tax benefits from investing in ELSSs.And as the equity markets are not to so frothy now ELSS might give good results in 3 years time.But do remember returns from ELSS  fluctuate depending upon the performance of the equity market and also the stock selection criteria of the particular fund manager. Returns from ELSS could even be negative.That said even the worst perfomers seem to deliver returns similar to the PPF in the medium to long term.However a greater concern is what is likely to happen from next year onwards, if there are no tax benefits for investing in these schemes.Will people will start exiting them big time so that the NAVs of these funds drop significantly?Only time will tell.

Personally I plan on continuing my regular contributions to the PPF.My product of choice for this year’s tax-savings are the tax saving FDs for their guaranteed high returns.However I am planning a few small ticket investments in ELSS to hopefully better returns.To reduce risks from possible large scale redemptions I choose to invest in two or three funds and will watch for further news about the DTC.These alas will not be such passive investments.