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Equity Linked Saving Scheme (ELSS Funds)

How To Choose An ELSS Scheme?

Considering the fact that we have learned previously that; how ELSS is a better tax-saving instrument than others. Let us now discuss how to choose an ELSS fund for yourself or what are the different criteria you should look at while choosing an ELSS fund for investing and also for the purpose of saving tax. 

 

So, selecting the right ELSS scheme is extremely important since investing in the wrong ELSS scheme can be quite dangerous. Here are some of the factors that you must check before deciding on the best ELSS in which you can invest.

 

Remember, that spending some time and effort in doing careful research before investing can help you to choose the winning funds that are also expected to perform well in the future.

 

Caution:

 

All investment in equity shares and equity Mutual Funds, including ELSS investments are subject to market risk. No matter how well you research, there is always a possibility that the fund you choose may not perform as per your expectation if the stock markets do not do well. Keeping this factor aside, by doing careful research, we can, however, evaluate the health of a fund and try to pick the best performers in which we can invest.

 

Doing solid research is very important, but it can never guarantee profits.

 

1. Asset Under Management

The thumb rule is that you should invest in an ELSS which has a large Asset Under Management (AUM). When a fund manager has a large corpus to invest, then he or she can make robust decisions and draw up better strategies to generate returns. A fund with a low AUM will not give this flexibility to the fund manager and he or she will have to work under severe constraints.

 

Another big risk of investing into an ELSS with low AUM is that in case a big investor exits from the fund, then the stability of the ELSS will be at stake. The AUM will become even smaller in that case. Since you  are  locked  in  for  3 years, you will not be able to  exit from it,  resulting in  unnecessary losses for you. 

 

2. Performance ranking

Most investors only look at the returns generated by the fund in the short and the long terms while purchasing an ELSS. While that is important, it is  also very important to look at how the ELSS are compared to its peers in terms of performance. This is where performance ranking comes in.

 

Every ELSS is assigned a Quartile ranking depending on their relative performance vis a vis all the other funds. They are classified into four Quartiles numbered 1 to 4. The top performers are classified in Quartile 1 and the worst performers are classified as Quartile 4.

 

Needless to say, always try to invest in the funds belonging to the top Quartiles, i.e. 1 and 2. Avoid choosing the low performers classified in Quartiles 3 and 4.

 

3. Ratio analysis

Evaluating the Fund Ratios will help you to find out how an  ELSS is  performing based on certain preset parameters. While investing in an  ELSS it is very important to look at these ratios to understand whether the fund is worth investing in or not.

 

Some of the common ratios that will help you to understand the risk and return potential of all the funds better are Standard Deviation, Sharpe Ratio, Treynor Ratio, etc. 

 

You can easily find the current ratios from the websites of the respective Mutual Fund companies and of many other research sites like Mutualfundindia.com, Moneycontrol.com and Valueresearchonline.com.

 

We will discuss these ratios in detail in the next unit.

 

4. Total expense ratio

The total expense ratio is one of the most important ratios for any investor. It will tell you what percentage of the profits from the ELSS are being used to meet the management, administrative and distribution expenses of the fund. It is calculated as:

 

Total expense ratio = (Total Expenses Of The Fund) / (Total Assets Of The Fund)

 

The higher the Total Expense Ratio, the lower will be the return that you earn. Hence it is important that you choose a fund which has a relatively lower total expense ratio.

 

5. Fund manager’s performance

The fund manager is the captain of the ELSS ship, and it is he who takes most   of the decisions regarding the investments that the fund makes. Hence  it  is very important that the fund manager is strong and well experienced.

 

Before investing in an  ELSS, do  some research regarding the fund manager. Try to know his/her qualification, experience, track record, etc. Try to evaluate the performance of the other funds that he/she might be handling, and look out for any signs of an outstanding performance by any of those funds.

 

The fund manager’s performance can also be found out by looking at a fund ratio called Alpha. This will tell you the extra returns that the fund manager has been able to generate over and above the  average industry returns. A fund manager who has been able to generate a high alpha is considered to be better than another one who has just generated the industry average returns.

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Units 9/12