Mutual funds: ELSS lose shine; spotlight on sectoral funds

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You can invest a lump sum amount or invest every month through SIP. In fact, an SIP works best in falling markets when you can buy more units.

Equity-linked savings scheme (ELSS), a popular tax-saving investment option, is fast losing its sheen. Since January this year, this category has reported net outflow each month, barring March when it reported inflow of Rs 1,552 crore, data from Association of Mutual Funds in India show. Between January to October 2021, the net outflow was Rs 3,986 crore as investors preferred to invest in sectoral/ thematic funds with many capitalising extensively from the recent market rally.

Investors are not preferring to invest in ELSS due to the poor performance of most of the funds as compared with large and mid-cap funds. Typically, inflow in ELSS picks up in the last three months of the financial year, seen as the tax-saving season. However, with the new personal tax regime, many taxpayers are opting for the new flat rate without any exemption and are not investing in tax saving instruments like ELSS and unit-linked insurance plans.

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So, should you invest in ELSS?
Experts say investors must not invest in ELSS just for the purpose of saving tax. As equity-oriented investments give higher long-term returns, look at quality funds in multi-cap, large-and-mid caps and thematic funds categories which are currently better positioned. However, if you do not want to aggressively invest in equity-related instruments and just want to limit the investment to the tax saving amount, then you can look at ELSS.

Investment in ELSS up to Rs 1.5 lakh qualifies for tax rebate under Section 80C of the Income Tax Act. While ELSS has the lowest lock-in period of three years as compared to other tax-saving instruments (under Section 80C) such as Public Provident Fund, National Savings Certificate and five-year bank fixed deposits, understand what your expectations are. Also, every time you invest in an ELSS fund, it will get locked in for three years.

You can invest a lump sum amount or invest every month through SIP. In fact, an SIP works best in falling markets when you can buy more units. However, there is no guarantee on returns which can fluctuate depending upon the performance of the equity market and the stock selection of the fund manager.

Caution on sectoral funds
While investors are no longer finding ELSS funds attractive, they are betting on sectoral funds for higher returns. Many are looking at the short-term performance and want to add some of these funds in their portfolio. Sectors such as pharma, information technology, banking and consumer discretionary continue to draw the attention of investors.

However, sectoral funds carry significantly higher risk as they bet on the performance of a single underlying sector. Performance of such funds is cyclical in nature, and is more volatile compared to funds diversified across sectors. Most of these themes go through a cycle and may lack consistency over the long term. Also, fund managers cannot protect the downside by moving away from the sector in case the outlook for the sector deteriorates.

“These funds are for investors who have the understanding of the underlying sector or have right guidance available to make informed investment decision,” says Himanshu Srivastava, associate director, Manager Research, Morningstar India.

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