DIFFERENT TRACKS Unlike funds with a clearly defined investment universe -- large-cap, mid-cap or multi-cap - Tax Saving Schemes do not specify investment focus

If you are looking for an equity Linked Savings Scheme (ELSS) to pare your tax burden, the plethora of options may confuse you. Many investors simply opt for ELSS funds, also called tax saving schemes with the best return over a certain time period. However, this may not yield the best results. There are several types of ELSS funds and it requires a nuanced approach to pick the right one.

DIFFERENT RISK PROFILES

Unlike funds with a clearly defined investment universe -- large-cap, midcap or even multi-cap schemes in the ELSS category do not specify their investment focus. While these schemes have the flexibility to invest anywhere, most tend to follow a defined template.

For instance, some funds take a distinct large-cap tilt with a limited exposure to mid or small-cap stocks. Others prefer a higher exposure to the small-cap basket, with a modest large cap exposure, mostly intended to ensure liquidity in the portfolio. Some maintain a balanced portfolio, while a few adopt a more fluid approach, changing the portfolio mix according to market circumstances.

This difference in investment focus is evident in the portfolio of ELSS schemes. While the median portfolio market capitalisation (average market cap of a company a fund invests in) for ELSS funds is around Rs 36,000 crore, there are schemes with average portfolio market cap as high as `87,500 crore and as low as `13,000 crore, highlighting the disparity in the portfolio construction across ELSS funds.

A differentiated approach to portfolio construction means that the risk profile of ELSS funds varies substantially across schemes. Fund selection, therefore, is critical. The choice of fund should ideally be based on your risk profile, and not purely on a fund's return profile.

Investors should identify the nature of underlying exposure of the ELSS funds to ensure that the scheme objectives are in line with their own requirements.

If you are looking for an aggressive tilt and higher alpha or excess returns and can stomach volatility, then a scheme with a clear mid-cap bias would suit you better. Funds like Reliance Tax Saver, Sundaram Tax Saver and IDBI Equity Advantage come under this category .

For those who prefer stability over alpha, funds with a conservative, large-cap orientation would be a better fit. Franklin India Taxshield, DHFL Pramerica Tax Savings and Edelweiss Tax Advantage comprise such funds. Schemes like Axis Long Term Equity, Birla Sun Life Tax Plan, ICICI Prudential Long Term Equity, among others, have a more balanced portfolio.

Identifying the investing focus can also help you zero in on an ELSS fund that best complements your equity fund portfolio. If your existing portfolio is heavy on large-cap funds, you may opt for a tax-saving fund that focuses on mid-caps. Investors need to assess the risk-adjusted performance of funds in this category. It is critical that investors understand the risk involved owing to the portfolio mix. Mid-caps can fetch far higher returns but can witness a sharp fall during a correction. Also, keep an eye on the expense ratio while selecting the fund. A high expense will eat into your returns over time.

Already INVESTED IN ELSS Funds? What Next

For existing investors, this may be a good time to review their investment and see if the fund merits a place in your portfolio.

Some investors have the habit of opting for a different ELSS fund every year. This is far from ideal. Since you would also be holding a few traditional diversified equity funds, having more ELSS funds will lead to an overlap in your portfolio.

Try to limit your ELSS investments to one or two schemes. A financial adviser would be best placed to guide you towards the right ELSS fund, after considering your existing investments and risk profile. Don't be in a hurry to redeem your investment after the mandatory three-year lock-in period. Experts suggest staying with the fund for as long as one can.

Also, tax saving should not be the sole criterion for picking an ELSS fund. These funds are also suited for wealth creation over a long term and patient investors can reap rewards by staying invested for a reasonable period.