ELSS – Equity Exposure + Tax Savings = Deadly Combination in a ‘Down’ Market

by Shiv Kukreja on December 24, 2012

in Opinion

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at [email protected]

A few days back I was watching CNBC-TV18 in the morning when the markets were about to start trading. Udayan Mukherjee and Mitali Mukherjee were talking to Prashant Jain about his expectations from the stock markets in 2013. Let me tell you Prashant Jain is the Chief Investment Officer of HDFC Mutual Fund and the fund manager of two of HDFC MF’s most popular schemes, HDFC Top 200 and HDFC Equity Fund, among others.

Let me also tell you that I try to regularly follow Prashant’s thoughts on investment environment and earnings expectations.

He shared his views that the markets are trading at a forward Price/Earnings (P/E) multiple of 13.5 to 14.5 times, based on the FY14 Sensex earnings per share (EPS) of Rs. 1350 to Rs. 1450, which is below the average P/E multiple of 17 times. As per him, the retail investors always lose money in the stock markets because of their poor timings of entering and exiting the stock markets.

He further said that it is unfortunate but the stock markets always get retail investors’ investments when the P/E multiples are on a higher side, say above 17-18 times and they always cut their holdings when the markets just start their journey to newer highs and the P/E multiples are on a lower side, say around 13-14 times.

If you analyse the current markets scenario when the Sensex has risen past 19000 levels, many of the investors are doing exactly the same what Prashant is suggesting. On the one side, they are either redeeming their mutual funds or surrendering the mis-sold ULIPs or cutting their holdings in stocks/booking profits too early. On the other side, they are increasing their asset allocation towards the debt/gold instruments like fixed deposits, tax-free bonds, NCDs, Gold ETFs etc.

Some investors think that if the markets have risen from 16000-17000 levels to 19000-19500 levels, it is better to sell their investments in mutual funds or shares as the markets will again fall to sub-17000 levels due to some reason and these stocks will again take 2-3 years to reach these levels.

Is this a prudent investment strategy to earn above average market returns? Definitely Not. It is next to impossible to predict the definite direction of stock markets. A common investor should invest in the markets when the markets are cheap and continue investing till the markets remain cheap. When to sell? The answer is very simple – when the markets are expensive or the P/E multiples are above reasonable levels, say above 20-22 times.

But honestly speaking, it is very difficult to follow it practically because when the markets become expensive, the growth in EPS is very strong and we get driven away by some rosy pictures getting published daily in the newspapers. Also, our greed grips us so strongly that we are just not able to book profits.

So, when the markets are down, it offers a very good opportunity for the investors to invest in direct equity or equity linked investment products. Moreover, if any of these instruments provide you an additional tax benefit u/s. 80C also along with completely tax-free returns on maturity/redemption, I think it makes it a perfect investment for most of the investors.

As per a CRISIL report published earlier this year, it showed that Equity Linked Savings Schemes (ELSS) have been better investment options than PPF, NSC etc. It showed that these schemes delivered an average annualised returns of around 22% in the last 10 years. PPF at present earns 8.80% per annum for you and that is also tax free at maturity.

The table below shows a comparison between ELSS and PPF. With similar returns of 8.80% and 22%, your Rs. 1 lakh invested today in PPF and ELSS would become Rs.2,32,428 and Rs. 7,30,463 respectively after 10 years.

Some good performing ELSS have delivered very good returns in the past 1 year period. But, I think investors should also observe their long-term performances. The table below shows the list of five such schemes with their 3-year and 1-year performances.

With a lock-in period of 3 years, I think tax saving mutual funds (ELSS) as a category should outperform all other tax saving products in the next 3-5 years. But, for that, the corporate profitability should improve and the government should start taking steps in the right direction. Lets see how these funds deliver in the times to come.

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