7 good tax-saving funds to buy

[K.Karthik Raja]

7 good tax-saving funds to buy

If you don't want inflation to munch out a big part of your savings as
you invest to cut your tax burden, you should look at equity
investment. Equity-linked savings schemes (ELSS), whose returns are
far ahead of that from traditional tax-saving instruments like Public
Provident Fund (PPF) and National Savings Certificate (NSC), is what
you need.

Three-year returns from most ELSS funds have been around 30-50 per
cent over the last five years, and the 8 per cent returns from
guaranteed return products look paltry in front of them.

An ELSS is a diversified equity fund that comes with a 3-year lock-in
period and offers tax benefits under Section 80C of the Income Tax
Act.

Before selecting an ELSS, ensure that your investment takes into
account your risk profile and the overall asset allocation of your
portfolio.

Remember that the higher returns from ELSS come with higher risk as
they are market-linked. These schemes are suitable for investors
willing to trade lower risk for better returns from their tax saving
investments.

How to evaluate an ELSS?

ELSS funds should be evaluated on the same parameters that are applied
to other equity funds. Funds with a longer performance history should
be preferred over newer funds.

The longer the performance history, the longer time a fund has to test
its mettle in various market situations. It would be easier for the
investor, too, to evaluate consistency in the fund's performance. The
performance of the fund should be compared with that of its benchmark
and peers.

An investor should also assess the risk and return strategy of the
fund and take a call on whether he is comfortable with it. Fund houses
with strong and established processes and the ones that focus on fund
management teams rather than the individual are better.

Choosing the fund

The biggest advantage of an ELSS is that it allows investors to choose
products according to their risk appetite. The suitability of a fund
depends upon the compatibility of the fund's strategy with the risk
appetite of the investor.

The focus of the fund's portfolio to different segments of the market,
such as large-, mid- and small-cap, gives an indication of the
volatility that an investor can expect in a fund.

Moreover, the 3-year lock-in reduces the risk in equity investing to a
great extent and allows the fund manager to choose stocks with long-
term potential without liquidity concerns.

We have picked seven schemes for you, and categorised them as
conservative and aggressive. The schemes taken here have at least
three years of performance history.

Apart from that, they are well diversified funds and would form part
of any selection process based on their past performance and robust
portfolio strategy.

Less aggressive funds

SBI [Get Quote] Magnum Taxgain: The top performing fund in the 3- and
5-year time frame, SBI Magnum Taxgain retains the flexibility to move
into whichever market segment it sees opportunities in. Its mid- and
small-cap focus in 2003, 2004 and 2005 reaped huge returns.

The fund's 3-year and 5-year returns of 59.93 per cent and 69.43 per
cent, respectively, make it one of the top performers in this space.
Since the mid-2006 market crash, it has slowly shifted focus to large-
caps. At Rs 3,782 crore (Rs 37.82 billion), it is one of the largest
funds in the category and may make it difficult for the fund to take
substantial exposure in the mid and small cap segments of the market.

The past performance of the fund and its ability to move into various
segments of the market makes it an attractive proposition for
investors willing to put up with a degree of uncertainty for higher
returns.

Sundaram BNP Paribas TaxSaver: A top performing fund in the category
with returns of more than 45 per cent over a 3-year period, this fund
again has the flexibility to invest across market segments and has
done so successfully in the past.

The fund has always maintained a well-diversified portfolio with 55-60
stocks. So, even if one, or few stocks underperform, the overall
performance won't be much at risk.

The fund has reduced its large-cap exposure in the last quarter of
2007 unlike most funds that increased holdings in large-cap stocks
during the period. As a fund that can shift across segments, the
ability of the fund manager to identify trends early enough would be
crucial in the fund's performance and is suitable for investors
willing to take this risk.

HDFC [Get Quote] Tax Saver: This is another fund for investors, who
would prefer a large-cap orientation in their investment portfolio.
Though the fund had benefitted by moving into the mid- and small-cap
space in 2003 and 2004, it has focused on large-cap stocks in the last
two years.

The fund is among the top funds in the 3- and 5-year time frames
though it fell in the 1-year stakes. The 1-year rolling return of the
fund at 40.55 per cent still keeps it among the top schemes with more
than three years of performance track record.

Franklin India Tax Shield: This scheme is suitable for investors who
like steady returns with no surprises. Its biggest advantage has been
its ability to negotiate market downturns.

The fund has given negative returns in only four of the 20 quarters.
It finds a place on this list on the back of its consistent large-cap
focus in its portfolio.

The returns from the fund at 29.17 per cent, 38.65 per cent and 45.95
per cent over one, three and five years, respectively, have been
steady rather than spectacular. Investors willing to trade return for
the comfort and lower risk of a large-cap portfolio can consider this
scheme.

Aggressive funds

Principal Tax Savings Fund: This is another candidate for investors
willing to take greater exposure to the mid- and small-cap segments.
The fund has been among the top five schemes over one, three and five
years and has consistently beaten the benchmark and the category
average.

The fund is suitable for investors who are willing to take a higher
exposure to the more volatile small-cap segment since the fund has a
substantial exposure to it. The 3-year lock-in gives the fund manager
the leeway to take such calls. Nevertheless, the fund is not for the
faint-hearted.


Birla Sun Life Tax Relief '96: This is another multi-cap fund that has
been a steady performer. It has consistently outperformed both the
benchmark and the category average. It took a large-cap tilt in its
portfolio after the mid-2006 market crash.

The fund has taken concentrated exposure to the financial services
segment and has benefited from it as is evident from its 1-year
return--41.66 per cent. The fund is suitable for investors willing to
take greater risk associated with a higher degree of concentration
both in sector and stocks.

Birla Equity Plan: For investors who are willing to take an extra dose
of risk to benefit from better returns can invest in this fund that
has always maintained a majority of its assets in mid- and small-cap
stocks.

With returns of 40.94 per cent in the 3-year time period and 52.51 per
cent in the 5-year period, the fund has done well to reward its
investors. From a concentrated portfolio of 32-35 stocks, the fund has
gone to a more diversified portfolio of 45-50 stocks in the last six
months.

While this reduces the risk in the fund, it also limits the gains from
good stock picks. With a fund size of Rs 196 crore (Rs 1.96 billion),
the fund is still small enough to be nimble while moving in and out of
sectors and stocks. The fund is a good pick for an investor with a
higher risk appetite.


How to make most of your ELSS investments?

ELSS should be treated as part of the overall portfolio, and not
merely as a tax-saving instrument. By keeping a few strategies in
mind, an investor can make the most of his investment.

Keep financial goals in mind: Every ELSS adopts different stock
picking strategies. Some schemes such as Franklin India Tax Shield
maintain a large-cap focus and are suitable for investors who have a
lower risk profile.

On the other hand, funds that have greater exposure to small- and mid-
cap stocks, such as Principal Tax Savings Fund, fit the portfolio of
an investor willing to take a higher degree of risk. Ignoring this
aspect would lead to a mismatch between the fund and the investor's
profile.

Diversify among styles: The role of the ELSS in a portfolio is
restricted to providing tax benefits without compromising on the
return. It cannot form the core of a portfolio. A portfolio should
ideally stick to at best two schemes with varying investment styles
and market focus.

Periodic investments: Identifying the scheme and starting a systematic
investment plan (SIP) would ensure that the investor benefits from
lower acquisition costs through rupee cost averaging in a volatile
market. Investing periodically also spreads the burden.

However, remember that each installment will be subject to a 3-year
lock-in. So, if you enroll in a 3-year SIP and invest systematically
every month for three years, you will get your entire proceeds only
after six years, after your last installment (at the end of the third
year) completes three years.

Growth or dividend option: Choosing the growth option ensures
compounding and capital appreciation in a mutual fund investment.
However, in case of an ELSS, the dividend payout option provides a
degree of liquidity even during the lock-in period.

The dividend paid out can be invested in other investment options,
whether equity or debt, depending upon the rebalancing needs of the
investor's portfolio and, thereby, reduce the risk in the overall
investment plan. From the tax perspective, both options are equally
efficient.

Don't chase NFOs: A new fund does not offer a track record to bank on.
Populating their portfolio with ELSS NFOs every year is a mistake that
many investors commit.

Buy from the company: Why pay Rs 2.25 entry load on every Rs 100 you
invest to the agent, now that we have identified the schemes for you.
Go to the fund office and buy.