Here is our update on Equity Linked Saving Schemes (ELSS) or tax saving mutual fund schemes in the new year. There are some changes in the recommendation list this month.

Looking for ELSS or tax saving mutual funds to invest and save taxes under Section 80C of the Income Tax Act? Here are our handpicked tax saving mutual fund schemes for you.

Here is our update on Equity Linked Saving Schemes (ELSS) or tax saving mutual fund schemes in the new year. There are some changes in the recommendation list this month. Two schemes -Principal Tax Saving Fund and L&T Tax Advantage Fund - are out of the list. We have not included any new tax saving schemes, as there are already six schemes in the list.

We were forced to drop Principal Tax Saving Fund as the scheme has consistently underperformed the benchmark and the category for a while. It has failed to perform in the last two years and stayed in the last quartile in 2018 and 2019. L&T Tax Advantage Fund also failed to perform. The scheme lies in third quartile in the last two calendar years. It is underperfoming its benchmark in the last two quarters.

We are very careful about including and excluding schemes from the recommendation list. We believe that chasing returns is a futile exercise. It is impossible to stay with the top performer through your investment journey. Every schemes goes through ups and downs and it is extremely important to give enough time for schemes to perform. You can see that we have given enough time for these schemes to perform before excluding them from the list.

Also, a word about the relative underperformance of Aditya Birla Sun Life Tax Relief 96. Though the scheme has improved its performance marginally, it is still is not out of woods. Its higher exposure to mid cap and small cap stocks could be the reason for the lackluster performance. We will keep watching the performance of the schemes closely.

As you know, investments in ELSS funds qualify for tax deductions of up to Rs 1.5 lakh under Section 80C of the Income Tax Act. If you have a higher risk-tolerance and long-term financial goal, you can consider investing in ELSS funds to save taxes.

However, investors should remember a few points before investing in these tax-saving schemes: one, do not invest in ELSS simply because they have the potential to offer superior returns over a long period. You should invest in ELSS only if you have a higher risk appetite to invest in stocks or equity. Equity, as you would know, is a risky asset class; it can also be very volatile in the short term. Of course, it has the potential to offer superior returns over a long period. However, that alone need not be the criteria to invest in ELSSs.

If you don’t have the necessary risk appetite, do not invest in them. Just remind yourself that ELSS funds invest mostly in stocks and you do not have the stomach for extra risk and volatility. Happily sacrifice those extra returns and be happy with the traditional favorites like Public Provident Fund (PPF), 5-year bank deposit, and so on.

Two, you must have heard the sales pitch that ELSS funds have the shortest mandatory lock-in period of three years among the tax-saving investment options available under Section 80C. Yes, tax saving mutual funds have the mandatory lock-in period of only three years. However, that doesn’t mean you should invest in them with a horizon of just three years in mind. Since they are essentially equity mutual fund schemes, you should invest in them with an investment horizon of at least five to seven years.

Finally, include your ELSS investments in your overall financial plan. They are ideal to meet your long-term financial goals. You need not rush to redeem them as soon as they complete the mandatory lock-in period of three years. You may hold on to these schemes as long as they are performing well. However, you must sell them a few years before the financial goal assigned to them. This is to ensure that your corpus is not adversely hit by a sudden bout of volatility in the stock market.

If you still want to invest in ELSS funds but don’t know which schemes to choose, here are our recommended Equity Linked Saving Schemes or tax saving mutual funds to invest in 2020.

Best ELSS mutual funds to invest in 2020
- Motilal Oswal Long Term Equity Fund
- Aditya Birla Sun Life Tax Relief 96
- Invesco India Tax Plan
- Axis Long Term Equity Fund
- Mirae Asset Tax Saver
- DSP Tax Saver

We will update you on the performance of these schemes every month. If you want to know about the methodology employed to choose these schemes, please go through it below:

Methodology:
ET.com Mutual Funds has employed the following parameters for shortlisting the Equity mutual fund schemes.
1. Mean rolling returns: Rolled daily for the last three years.
2. Consistency in the last three years: Hurst Exponent, H is used for computing the consistency of a fund. The H exponent is a measure of randomness of NAV series of a fund. Funds with high H tend to exhibit low volatility compared to funds with low H.
i) When H = 0.5, the series of return is said to be a geometric Brownian time series. These type of time series is difficult to forecast.
ii) When H is less than 0.5, the series is said to be mean reverting.
iii) When H is greater than 0.5, the series is said to be persistent. The larger the value of H, the stronger is the trend of the series
3. Downside risk: We have considered only the negative returns given by the mutual fund scheme for this measure.
X =Returns below zero
Y = Sum of all squares of X
Z = Y/number of days taken for computing the ratio
Downside risk = Square root of Z
4. Outperformance: It is measured by Jensen's Alpha for the last three years. Jensen's Alpha shows the risk-adjusted return generated by a mutual fund scheme relative to the expected market return predicted by the Capital Asset Pricing Model (CAPM). Higher Alpha indicates that the portfolio performance has outstripped the returns predicted by the market.

Average returns generated by the MF Scheme =
[Risk Free Rate + Beta of the MF Scheme * {(Average return of the index - Risk Free Rate}
5. Asset size: For Equity funds, the threshold asset size is Rs 50 crore

(Disclaimer: past performance is no guarantee for future performance.)