Stick to existing ELSS schemes

Avoid closed-end tax-saving NFOs, as there are plenty of open-end funds available with a proven record

The tax season is here.

Investors now have two more equity-linked savings scheme (ELSS) to choose from, with Sundaram Mutual Fund recently launching a 10-year closed-end ELSS scheme, Sundaram Long Term Tax Advantage Fund - Series 1. This follows a similar 10-year product launched by SBI Mutual Fund in October-end.

Both schemes come with a compulsory lock-in of three years, after which investors can choose to remain invested till maturity. While SBI Long Term Advantage Fund – Series 1 is benchmarked against the S&P BSE 500, Sundaram’s scheme is benchmarked against CNX 100 index. Both  funds are currently open for subscription and close on January 31 and March 20, respectively.

Are these worth investing? The advantage with closed-end ELSS funds is that the fund corpus remains stable for the first three years, since there are no inflows and outflows in the scheme during the period. This means the fund manager does not have to worry about liquidity issues, at least for the first three years, and can take higher risks keeping in mind the three-year investment horizon. Even after the completion of three years, investors can only redeem their units; no fresh investment is allowed. These schemes will be listed at the stock exchanges, which provides investors a route to exit.

“Since there are no fresh inflows, fund managers do not have to buy into new stocks or buy stocks they already hold at higher prices. This will prevent dilution of returns for existing investors,” said Sunil Subramaniam, deputy chief executive officer, Sundaram MF. For an investor’s perspective, it means if the fund manager has bought a stock and it goes down, the fund manager won't be able to buy and average out costs.

Another problem is that investors cannot invest through systematic investment plans (SIPs) in closed-end products. Open-end ELSS schemes allow investors to put in money through SIPs, wherein each SIP amount is locked in for three years and becomes eligible for tax relief under Section 80 C. Experts advocate investing through SIPs, as they work on “rupee cost averaging”, meaning more units are purchased when a schemes’ Net Asset Value (NAV) is low and fewer units when the NAV is high.

As a general rule, experts believe it is much better to invest in existing funds rather than new fund offerings (NFOs) that do not have a proven record. “An existing fund adds to the comfort factor as it allows investors to study past returns and the fund's performance across different market cycles,” said Suresh Sadagopan, a certified financial planner.

There are 12 closed-end ELSS schemes in the market currently, compared with 37 open-ended schemes. The closed-end group of schemes have underperformed the overall average category returns of ELSS schemes by anywhere between 1.4 and 2.3 percentage points over one, three and five- year periods, according to data from Value Research, an MF tracker.

The other big disadvantage to an investor is that as each closed-end series is effectively a small fund, an investor could end up paying a higher cost than a large-sized open- end fund. The cost, or total expense ratio, for managing such a series could be as high as 2.5 to 2.7 per cent compared with 2 to 2.2 per cent for an open-ended fund, said experts. the total expense ratio or TER is the annual charge deducted from the net asset value of the scheme.

Typically, larger the fund, lesser the TER it charges  investors. In the Sebi guidelines, funds can charge a maximum TER of 2.5 per cent for the first Rs 100 crore of assets, 2.25 per cent for the next Rs 300 crore, 2 per cent for the subsequent Rs 300 crore and 1.75 per cent for the balance. Funds can also charge an additional 0.30 per cent if 30 per cent of their inflows come from regions other than the top 15 cities in the country.

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