Equity linked savings scheme trumps PPF on returns

A penny saved is a penny earned. In the long run, those who follow this simple yet very powerful principle would probably be more financially sound than those who don’t. And those who go one step further by not just “saving” but “investing” in appropriate asset classes and products would likely benefit all the more.

Equity Linked Savings Schemes (commonly known as ELSS schemes) offered by mutual funds combine these two principles to create a product that not only help investors to save tax but also has the potential to help build wealth in the long run. However, ELSS funds differ from most of the other tax saving investment instruments in terms of their risk-return characteristics and for that reason, many investors tend to prefer traditional tax saving investments over ELSS funds.

Fidelity Worldwide Investment conducted a study based on the historical long-term performance of ELSS funds in the Indian mutual fund industry. As a first step it identified all the open-ended ELSS funds which have been in existence for more than 10 years (in existence since October 2001) and then calculated the CAGR of each of those funds for a five-year period at every month end starting from October 2006 to October 2011. 

This resulted in a total of 61 data points, the first five year period was from 31-Oct-2001 to 31-Oct-2006 and the last five year period was from 31-Oct-2006 to 31-Oct-2011. Further, using the above performance numbers we calculated the simple average performance of these funds for each of the time periods. Lastly, the results were compared against the rate of return that investors in PPF or NSC would have earned for each of those five year periods.

The results clearly show that ELSS funds’ average returns have been better than PPF/ NSC in 58 out of 61 periods and average five year annualised performance of ELSS funds was 26.43 per cent as compared to average PPF rate of 8.32 per cent and average NSC rate of 8.59 per cent — an out performance of 18.11 per cent and 17.94 per cent respectively.

In other words R1 lakh invested in ELSS funds on an average would have grown to R 3,23,036 in a five-year time-frame whereas the same amount invested in PPF or NSC would have grown to just Rs 1,49,120 and Rs 1,50,317 respectively. It was also interesting to learn that more than three times out of five, ELSS funds outperformed PPF by over 10 per cent on an annualised basis.

Like evaluating any other investment option, it is equally important to understand the associated risks. As the study revealed the range of returns from ELSS funds over different time periods and the divergence of returns (and hence the risk) reduces with increase in investment horizon.

For example, over a three-year period, the average CAGR of ELSS funds have been in the range of 9.15-76.75 per cent but if the investment horizon is increased to 5-years, the return range narrows down to 7.03-53 per cent.

Like most equity funds, ELSS funds also tend to be volatile in the short term but have the potential to help investor generate wealth in the long run. Their wealth generation potential along with the compulsory minimum investment period of at least three years makes it a great investment option for investors looking to benefit from tax deductions under Section 80C.

Source: http://www.indianexpress.com/news/equity-linked-savings-scheme-trumps-ppf-on-returns/916999/0