With the end of the financial year drawing near and offices demanding proof of tax-saving investments, a lot of people will buy tax-saving products like tax-saver (equity linked saving schemes or ELSS) funds in the coming days. Since such last minute purchases are made in a hurry, a lot of mis-buying and mis-selling happens at this stage. Do some research before deciding to invest in an ELSS fund.
First, look at the nature of the ELSS fund: whether it is large-cap, multi-cap or mid-cap oriented. “Take into consideration your own risk profile while choosing a tax-saver fund” says Vidya Bala, head of research, Fundsindia.com.
Conservative investors should opt for a large-cap oriented ELSS, while those with a higher risk appetite may opt for a multi-cap oriented ELSS fund. The style sheet of a fund will tell you about its market cap orientation.
Next, look up the track record of the fund. When looking at trailing returns (one-year, three-year, five-year), give higher weightage to longer term returns. Do look at calendar year wise returns of funds over the past five to seven years (versus category average) as well to know if the fund has been consistent.
Turn to the nature of the portfolio next. The equity count (number of stocks held by the fund), stock and sector concentration (in the top 10 sectors and stocks) of the fund tell you whether it has a concentrated or diversified nature.
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While a more concentrated fund can give you higher returns, it can also fall harder if the fund managers calls go wrong. If you have to choose between two funds with similar levels of returns, you will be better off going with a well-diversified fund. Remember also that beyond 25-30 stocks, there is not much added benefit from diversifying further.
The size of the fund isn’t a primary criterion, say experts. “Large AUM (assets under management) becomes a deterrent to performance only in the mid- and small-cap space, not in case of large-cap funds,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors. The fund size, however, shouldn’t be very small (below Rs. 100 crore) or else there is the risk of the fund house closing down or merging the fund.
The level of risk that the fund takes to fetch its returns is also important. Make sure that the funds risk-adjusted returns (indicated by Sharpe ratio and Treynor ratio) are above category average.
Next, look at how much the fund manager churns his portfolio, as indicated by the turnover ratio. Go with funds that opt for a buy-and-hold approach.
Give preference to funds with a low expense ratio. Pay a high expense ratio only if it is justified by the fund’s performance.
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Avoid funds that take very high cash calls. A fund that moves into cash in a big way during a market downturn risks getting left behind when the market starts moving up again.
Finally, look for constancy at the helm. The same fund manager who was responsible for producing the fund’s returns should be still managing the fund. If the fund manager has changed and a new man has taken charge, then the funds track record loses its meaning.
Information about many of the parameters mentioned above is available on the web sites of rating agencies. Finally, next financial year onward start an SIP in an ELSS so that your tax planning doesn’t happen at the last moment.