Its that inconvenient time of the year again - when everyone is figuring out how to put money in tax saving investments before the end of the financial year. For decades, this meant investing in insurance policies or PPF accounts. However, there are now many more investment options eligible for tax exemption, and one that has become especially popular  is ELSS (Equity Linked Savings Schemes). 

ELSS are covered under Section 80C of the Income Tax Act and can claim a tax rebate of up to Rs 1.5 lakh. These are essentially a category of mutual funds that are commonly known as tax-saving mutual funds. These mutual funds primarily invest in stocks. 

A key condition attached to these funds is a three-year lock-in period. investors cannot redeem them under any circumstances during that time. The logic is that this helps ensure better returns while saving investors tax. 

Do the funds actually deliver? Let us consider the past three years of investing in ELSS funds and check whether they have given investors above-average returns, or simply met the goal of tax saving.

Very few clear winners in the ELSS category of mutual funds

Our analysis has identified ELSS schemes that have given positive returns in the past year and higher than 16% annualised returns over the past three years, with 16% being the average three-year return CAGR for this category. Leading the three-year return  are Quant Tax Plan Gr (37.0%),  Parag Parikh Tax Saver Reg Gr (21.9%), IDFC Tax Advantage (ELSS) Reg Gr (21.4%), PGIM India ELSS Tax Saver Reg Gr (18.3%) and HDFC TaxSaver Gr (16.1%), which can be considered the top schemes in this category.

The past three years have been an unusual period for ELSS investments.  The investment would have been done in January 2020, just before the Covid pandemic shut down businesses and mobility worldwide. . Investors saw their ELSS investment value drop drastically with the onset of the pandemic, with no option of an exit till the lock-in period ended. With the lock-in period ending this January, they are now free to redeem non-performing ELSS funds or continue their investment in better-performing ones.

The standout performance in this category comes from Quant AMC’s Quant Tax Plan Gr managed by Vasav Sahgal and Ankit Pande, with a three-year CAGR of a staggering 37%. On a one-year basis, this fund delivered 7.0% returns, in a year when only 10 out of 61 funds in this category delivered returns above 4%. 

Around 50% of the schemes delivered negative returns over the past year. This disparity in returns has fuelled the debate on passive vs active funds. Statistically, well-managed active funds will always perform better than passive funds, but these outperformers would be limited to the top 10% of funds in each category.

Each fund manager has a distinct strategy to generate alpha

Comparing the composition of top-performing schemes, each fund manager has a different approach to fund allocation according to market capitalisation. While IDFC Tax Advantage (ELSS) Reg Gr, managed by Daylynn Pinto, has close to 20% exposure to small-cap funds, HDFC TaxSaver Gr, managed by Roshi Jain and Priya Ranjan, limited small-cap exposure to 3.8%.

As distinct as the approach to market capitalization is, the number of stocks in each scheme also varies. Parag Parikh Tax Saver Reg Gr managed by Rajeev Thakkar and Raj Mehta has only 30 stocks in the portfolio, while Quant Tax Plan Gr has  51.

One pattern seen among the top-performing funds is that most of them have relatively lower AUMs (Assets Under Management) compared to peers. PGIM India ELSS Tax Saver Reg Gr managed by Srinivas Rao Ravuri and Utkarsh Katkoria has an AUM of only Rs 448.3 crore, while Parag Parikh Tax Saver Reg Gr has Rs 941.6 crore. 

Funds with larger AUMs underperform in this category

HDFC TaxSaver Gr is the only scheme with an AUM close to Rs 10,000 crore that has delivered positive returns over the past year. Schemes with the largest AUMs in this category, Axis Long Term Equity Gr, Mirae Asset Tax Saver Reg Gr  and Aditya BSL Tax Relief 96 Gr LSP, have delivered negative returns, and only Mirae Asset Tax Saver Reg Gr delivered above 15% CAGR over the three-year period.

Another metric that sees wide variation among these schemes is the portfolio turnover ratio. This ratio defines the number of times the portfolio is churned or, in simple terms, how frequently are shares being added and sold in this scheme. 

Quant Tax Plan Gr has an extremely high ratio of 142%, indicating that the approach is driven by the churning of stocks and lesser holding period for each stock. On the other hand, Parag Parikh Tax Saver Reg Gr has a ratio of 5.3%, indicating that they are following a conservative approach and are buying stocks with a holding period of more than a few years.

Lastly, the ranks of these ELSS funds make all the difference when comparing their performance. There are a total of 61 schemes in this category. As long as a scheme is within the top 30 over different time periods, it is likely to deliver better returns to investors. Quant Tax Plan Gr maintains a high rank across time periods and Parag Parikh Tax Saver Reg Gr comes close. 

To sum up, ELSS as a tax-saving instrument is certainly growing popular with every passing year. However, the performance of a fund is more important as it is locked in for at least three years. While the category average of three-year returns is 16.3% CAGR, only half of the schemes have managed to surpass that benchmark. While choosing an ELSS fund, an investor should consider many factors and make an informed decision rather than invest with a lone objective of tax saving.