ELSS is the best bet

Given a choice, retail investors should prefer ELSS (Equity Linked Saving Schemes) to other open-ended equity funds. For those with a long-term investment horizon, it is the best way to participate in equities. It is also the best option whether for availing tax benefits or making regular investments.

Why is that so? Take a situation where a bearish phase leads to redemption pressures affecting open-ended schemes. While complete statistics are not available, it has been seen that often in situations where the market turns bearish, open-ended equity funds bear the brunt of redemption pressures.

While ELSS are open-ended, they have a lockin period of three years. This often discourages short-term investors, including corporates and high networth investors, from putting money into ELSS. On the contrary, this can be considered a blessing in disguise as ELSS are generally not infested with short term investors.

Since investment in these fund were done to avail tax benefits, the ticket size was usually lower and assets were spread across many investors. The advantage is that no single/few investors rule the roost and fund managers are also not forced to sell stocks that they might otherwise want to hold.

In the recent fall in share prices (and also a small rebound), ELSS schemes have taken a greater beating than the rest. In the last one year, returns from such schemes were slightly lesser than those from plain-vanilla diversified equity schemes.

While ELSS gave a return of 42.2%, diversified equity funds gave a 44.1% return. One of the arguments which is being forwarded is that some of the ELSS have a greater leaning towards mid-cap stocks which took a greater beating vis-à-vis large caps in recent times. Yet, if you are a long-term equity investor, ELSS funds could be the best investment vehicle. Of course, it goes without saying that the scheme you choose should also have a good track record.

Investors in NFOs (New Fund Offering) need to tread carefully though. More importantly, an investor should prefer funds with larger AUM. While a smaller asset base no doubt makes fund management simpler, it also is susceptible to exit by large investors.

Another problem lies in its expenses – initial issue expenses that the fund houses are allowed to charge to the scheme.

The Securities Exchange of India (Sebi) more than a year back came with norms to include NFO related expenses in the entry load and not charge it to the scheme for the open-ended equity schemes. Ironically, many of the NFO collections were made before Sebi made this announcement. And it would continue with the old rules.

Previously, if you subscribed to an NFO, mutual funds will charge you issue expenses every year for the subsequent five years. Taking the worst case scenario, if a mutual fund charged initial issue expenses to the extent of 2% of the collections, then the expense ratio of the fund could be 3% ever year.

This is in addition to the normal cap of 2.5% p.a that Sebi allows mutual funds to charge for other recurring expenses. As an equity investor, if you think you have over-invested into equities, then it’s the right time to pull out from NFOs. Do your due diligence and check the NFOs which have underperformed in recent times and also have charged higher issue expenses, and then prune them.