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ELSS Mutual Fund Preferences of Indian Tax Savers

Article  in  SSRN Electronic Journal · January 2018

DOI: 10.2139/ssrn.3296850

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Running head: ELSS Mutual Fund preferences of Indian Tax Savers 1

ELSS Mutual Fund preferences of Indian Tax Savers

VIJAYA KITTU MANDA
Research Scholar, GITAM Institute of Management,
GITAM Deemed to be University, Visakhapatnam, Andhra Pradesh, India 530 045
Contact: +91 98495 19188; Email: vijaykittu@hotmail.com

DR. ARUNA POLISETTY

Assistant Professor, GITAM Institute of Management,

GITAM Deemed to be University, Visakhapatnam, Andhra Pradesh, India 530 045
Contact: +91 99514 50046; Email: arunakovvuru@gmail.com

BEATRICE BETSY BABU

Postgraduate Student, Department of Commerce,

St. Aloysius College, Edathua, Kerala, India
Contact: +91 77369 34990; Email: beatricebetsy.babu@gmail.com

CITING THIS RESEARCH PAPER

Vijaya Kittu, Manda, Aruna, Polisetty, & Betsy Babu, Beatrice. (December 6, 2018). “ELSS Mutual Fund preferences of Indian Tax
Savers”. Two-day National Seminar on Mutual Funds - The Investment Hub of the Era: Current Perspective and Prospective
Reliability. Edutha, Kerala, India: St Aloysius College

ABSTRACT
Tax planning strategies are important for tax payers whose aim is to reduce their tax outgo on various types of income and capital gains.
While there are several tax saving instruments that qualify under Section 80C of the Income Tax Act, 1961, Equity Linked Savings
Scheme (ELSS) has a special importance. It provides the least possible lock-in period among all tax saving instruments besides providing
equity asset investment exposure making it a good long-term tool for wealth creation. This paper studies the investment behaviour of a
typical ELSS mutual fund investor.

Primary data is used to identify preferences of tax saving instrument by Indians and to understand if diversification across multiple
ELSS schemes is done. Understanding the mode of investing helps us get insight on investor behaviour. Finally, we get to know if ELSS
is being used by other family members. Secondary data study allows us to understand the trends and dynamics of ELSS. Our study
checks scheme Average Assets Under Management (AAUM) data to understand if investors delay and thereby hurry their investing just
before closing of the financial year. These findings are of significance for Asset Management Companies (AMCs) in their product
positioning and building promotional strategies. Market regulator SEBI and the Association of Mutual Fund Industry (AMFI) can use
it to improve the product offering and expanding its reach. Government and Ministry of Finance can use these findings for tweaking tax
laws so as to promote investment culture.

JEL Classification

7 C, 34 P, G23, G18, H24

KEYWORDS

investor behaviour, mutual fund, elss, assets under management, fund diversification, tax saving
ELSS Mutual Fund preferences of Indian Tax Savers 2

INTRODUCTION
Tax planning involves use of best available tax exemption and tax deduction instruments to reduce the tax outgo and there by maximize
income and capital gains in the hands of assessee. A typical tax payer can use several provisions from Section 80C through 80U under
the Income Tax Act, 1961 to reduce income tax outgo. Tax planners goal is to legally use various statutory provisions to reduce tax and
there by not indulge into tax evasion or tax avoidance. With proper tax planning, individuals’ tax liability can be reduced, litigation with
the tax department be minimized or even avoided, funds can be channelized into productive investments and thereby fuel economic
growth and stability.

Amongst the dozen-odd tax deduction instruments available, Equity-Linked Savings Schemes (ELSS) offered by Mutual Fund Asset
Management Companies (AMCs), Public Provident Fund (PPF), National Savings Certificate (NSC), National Pension Scheme (NPS)
and tax-saving bank fixed deposits are the most popular. As evident from increased inflows, ELSS schemes are becoming popular
because of the dual benefit of tax saving and long term wealth creation, thanks to the underlying equity asset class. ELSS with its lowest
lock-in period of 3-years makes it more attractive over other similar products. Returns from ELSS investment redemption are partially
taxable – at a concessional rate of 10% if gains are over Rs. 1 lakh - but this is not deterring investors.

Indian Mutual Funds have evolved a lot since their coming into existence with the establishment of the Unit Trust of India (UTI) in
1963. Remarkable growth is witnessed since 1987 when both private and public sector Indian banks and financial institutions are
permitted to start mutual fund business. Market regulator Securities and Exchange Board of India (SEBI) notified MF regulations in
1993 and since then, it is active and bringing timely reforms and regulations. As of October 2018, the Indian MF industry is managing
Rs 22.24 lakh cr Assets Under Management (AUM) under 7.9 crore folios. Monthly additions of Rs 7,985 cr via Systematic Investment
Plan (SIP) route and 53 consecutive months of increase in folios show that the industry will continue to see more inflows going forward.

Lack of investor awareness, conservative risk appetite nature, low penetration levels, higher dependence on corporate sector, lack of
confidence due to low returns, lack of transparency and ambiguity in rules and regulations are some industry challenges. While several
developments are happening, there is a lot of scope for improvement.

OBJECTIVES OF THE STUDY

1. To understand the concept of Tax saving and preferences

2. To study ELSS mf schemes and investor behaviour
3. To make suggestions to various stake holders as applicable

SIGNIFICANCE OF THE STUDY

1. Tax preferences and investor behaviour helps us prepare better investment products.

2. AMCs and Regulators can make product changes for better positioning.

3. Government and the Ministry of Finance can use the insights in their tax policy and Budget.

ABOUT ELSS
ELSS was introduced in the February 1989 Union Budget by the then Finance Minister, S.B. Chavan to incentivized the small investors
having low income tax obligation. The maximum amount eligible for the deduction was Rs. 10,000. This continued till March 31, 1991
when it was changed to tax rebate benefit under Section 88 of the Income Tax Act. It was again moved back to tax deduction benefit,
this time under Section 80C, from financial year 2005-06 onwards. The Ministry of Finance has officially announced ELSS under Equity
Linked Savings Scheme, 2005 (Ministry of Finance, Govt. of India, 2005). The eligible amount is revised to Rs 1,00,000 and later to
the present limit of Rs. 1,50,000 in 2014-15.

The number of ELSS schemes rose from mere 8 schemes managing Rs 11 cr. AUM in October 1999 to 42 open-ended schemes managing
Rs. 78,444 cr. and 28 close-ended schemes managing Rs. 4,258 cr. by the end of October 2018 (AMFI, October 2018). A typical Equity
mf scheme will have a minimum of 65% of its assets in equity and equity-related instruments. ELSS schemes will have this at 80% and
hence are aggressive schemes. Their lock-in provides the necessary investor patience to hold the investment. Most ELSS schemes have
S&P BSE 200 TRI Index as their benchmark index. Another interesting ELSS-exclusive index is the CRISIL-AMFI ELSS Fund
Performance Index with 22 constituent schemes.

AMCs started offering ELSS schemes since 1990-91 and have completed 28 years of existence. Canara Robeco Equity Tax Saver Fund
and SBI Magnum Taxgain Scheme (both launched in March 1993) are few of the oldest and still running ELSS schemes. Market data
ELSS Mutual Fund preferences of Indian Tax Savers 3

shows that ELSS scheme performance is a bit lower compared to Multicap Equity Funds and sometimes even when compared to index.
As many as 32 of 35 Regular Plan ELSS schemes have an expense ratio of 2% or above (as on Oct 2018), perhaps because of lower
AUMs. High expense ratio eats into ELSS returns thereby impacting scheme performance. (Krishna Kumar, August 2016)..

Statistics show that SIP is the most preferred route of investing in Mutual funds. Investor interest and attention is moving away from
traditional investment avenues such as real estate and gold to financial assets such as mutual funds, thanks to demonetization. The
minimum investment amount to start an investment in an ELSS scheme is Rs. 500 (unlike Rs. 1000 in case of most other Equity schemes)
and this makes it affordable for most investors. The Union Budget 2018 introduced long term capital gains (LTCG) on Equity gains.
ELSS being an Equity product, a 10% tax on capital gains after the initial Rs. 1 lakh on whole of long term equity gains after
grandfathering is to be paid. Though this might not have a substantial materialistic impact on the hands of investors, math calculation
lead to procedural burden and thereby increase compliance cost.

LITERATURE STUDY
Tax policies are designed to encourage individuals to work, save and invest so that these investments can be pooled up for productive
and planned use. Income tax changes shift capital resources towards highest-economic use sectors there by increasing productivity and
efficiency and hence aids in economic development (William & Andrew, September 2014). Increasing taxes need not only be positive
or only negative on growth buy “depends” on a number factors (Chye-Ching & Nathaniel, February 2014). Taxation is even more in
countries where even LTCG are taxable. Individual portfolio design is challenging because the investor has to keep in mind tax to be
paid and the purchase price. An optimal tax policy is path dependent and size of problem increases exponentially over time as equities
tend to outperform in the long run (Angel-Victor & Raman, February 2004). Fortunately, even after the recent LTCG tax after
grandfathering, Indian tax payer pays a very small tax compared to other countries.

Mutual Funds play a vital role in financial inclusion (Satya Sekhar, 2013) and thereby for the economic development of the country.
Financial literacy positively influences likelihood of investing in low-cost fund alternatives. Investors with less knowledge tend to seek
financial advisor who gets incentive for suggesting active funds. Further, even a sophisticated investor prefers active funds over low-
cost ETFs. Investors with good financial knowledge tend to study using internet channels and invest independently (Sebastian & Martin,
February 2010). MF investors are becoming increasingly aware about products and putting more attention on fund characteristics that
matter (such as risk, alpha and expenses) over less important ones (such as past returns) (Friesen & Viet, 2018).

Studies found that MFs perform well when investors need them the most! Fund mangers make good active contributions in recessions
and booms (Kosowski, November 2001). Findings by (George, March 2006) confirmed this on hybrid funds as well. However, 31 Indian
ELSS schemes between 1994-95 and 2001-02 showed that fund managers are not that successful in either getting excess returns or in
efficient portfolio diversification (Tripathy, July 2014). Different performance evaluation measures such as Rate of Return measure,
Treynor measure, Sharpe measure, Jensen measure, Sharpe differential Return and Fama’s Decomposition measure are studied.

Diversification is a good risk reduction tool. It is more of an Art than a Science. But, is MF diversification good and useful? Especially
when a single MF scheme invests in a basket of securities and thereby already diversifies. Moreover, some common overlapping stocks
across schemes increasing specific individual exposure and thereby MF diversification might actually increase risk. Since most ELSS
schemes have BSE 200 TRI Index as their benchmark, the stock selection universe for ELSS schemes will be limited. How useful is it
to diversifying across multiple ELSS schemes? There is a literature gap here but certain pointers give us insights. Studies shown that
portfolio diversification reduces standard deviation, kurtosis and VaR. But, return skewness reduces as well. Thus, moderate
diversification, say, with a five-fund portfolio is suggested (Junhua Lu, May 2007). Experience in direct equity shares show that
diversification is easier said than properly done because when adding new stocks, investors tend to pick those that are similar to their
existing companies and not at random as intended. This leads to bias (Don, Andrei, & Yang, December 2009). Further, there is a wide
variation in the number of securities in the portfolio. (Oliver, Ralf, & Ramun, May 2015) found that investors with below-average ability
in picking good performing funds can have superior returns with concentrated portfolio of large funds is superior over an optimally
diversified small/midcap strategy. Also, market efficiency-based simple model provides a good explanation of asset concentration over
other insignificant factors such as transaction costs or the behavioural aspects of investor choice (Yonathan & Farmery, 2010).

MF investor behaviour dependents on both liquidity needs as well as equity premium sentiments. Equity scheme inflows are negatively
correlated to flows into money market funds and precious metal funds, for example (William, Massimo, & Rouwenhorst).

RESEARCH METHODOLOGY
This study uses Descriptive research to gather preliminary information, observe tax saving patters, record their preferences and describe
possible implications. Quantitative approach is used in order to investigate the hypotheses.
ELSS Mutual Fund preferences of Indian Tax Savers 4

DATA COLLECTION
Both Primary and Secondary data is used as part of this study. Primary data with the help of a structured questionnaire is used to collect
data from 330 Indian respondents. The respondents are diversified in terms of age, gender and occupation. A pilot survey was carried
out in order to administer a simple structured questionnaire with 6 close ended questions to collect. Non-probability and convenience
sampling method was utilized in this study. The response rate was 100%. Secondary data is collected from several books, magazines,
research journals, websites including official websites of SEBI, AMFI and AMCs. Quarterly AAUM data of Axis Long Term Equity
Fund, SBI Magnum Taxgain Scheme, Reliance Tax Saver (ELSS) Fund, Aditya Birla Sun Life Tax Relief 96 and ICICI Prudential Long
Term Equity Fund for the period April 2011 to September 2018 is collected from AMFI website to study AUM trends. These top five
AAUM schemes represent over 50% AAUM of all ELSS schemes. Seasonal Index Analysis is used to check seasonality in AUM.

FINDINGS
1. ELSS (67%) is slightly more popular tax saving product over PPF (60%) and Insurance policies (57%).
2. ELSS investors are long term investors and loyal – they are using ELSS for over 3 years (31%).
3. Tax savers have totally divergent views with regard to ELSS – They are either very loyal to ELSS (31%) or totally stay away from
ELSS (25%).
4. Tax savers diversify across multiple products. Only 10% use ELSS as their only tax saving tool. 41% respondents have ELSS
allocation for less than 50% of the allowed Rs. 1.5 Lakhs tax saving.
5. Significant respondents (31%) mentioned they are not diversifying across multiple ELSS schemes. Holding single ELSS scheme is
actually good considering each scheme already diversifies adequately. 22% use two schemes and 15% use 3 or more schemes.
6. Most ELSS investors prefers SIP (53%) approach. Few invest according to their cash flows (12%) and by timing the market (10%).
7. ELSS inflows happen across the year. Most ELSS investors do not delay their tax saving till the last-minute March 31 deadline.
8. Family members of respondents hardly invest in ELSS (61%).
9. Majority ELSS schemes have high expense ratio (2% of over).

LIMITATIONS OF THE STUDY

1. Reaching out to more respondents would increase accuracy of the study.
2. Adding more factors than the 6 factors will make it more comprehensive.
3. Studying all schemes, instead of the selected 5 ELSS schemes, will help better understand seasonality nature of investment patterns.
4. AUM trends with respect to Regular and Direct plan and Growth and Dividend sub-options can be studied.
5. Only open-ended ELSS schemes are considered. Close-ended schemes and RGESS (now discontinued) can be studied as well.

CONCLUSION
This study made some interesting observations worthy of serious consideration. Educating and creating awareness on the benefits of
long-term equity investing in general, and on tax saving benefits from ELSS in particular, will increase ELSS penetration. Investors
should understand the difference between an Equity investing product (say ELSS) as compared to debt or savings instrument (such as
PPF) and an insurance product (such as Insurance). AMCs and AMFI can perhaps increase focus on this through their educational
campaigns and initiatives. Financial advisors and mf distributors can increase product awareness by suggesting ELSS not just as a tax
saving product but as a long-term investing tool for wealth creation as well. Further, other tax paying family members too should be
encouraged in using ELSS. Existing clients can be asked to consider increasing their ELSS allocations over other tax saving products
as well as suggest to their family members. AMCs should reduce expense ratio to improve returns and thereby gain investor confidence.
Government can consider increasing 80C limits to encourage long-term investing.

BIBLIOGRAPHY
1. AMFI. (October 2018). AMFI Monthly. Retrieved from http://portal.amfiindia.com/spages/amoct2018repo.pdf

2. Angel-Victor, D., & Raman, U. (February 2004). Portfolio Investment with the Exact Tax Basis via Nonlinear Programming.

3. Chye-Ching, H., & Nathaniel, F. (February 2014). What Really Is the Evidence on Taxes and Growth? A Reply to the Tax
Foundation. Center on Budget and Policy Priorities.

4. Don, M., Andrei, S., & Yang, T.-H. (December 2009). Experimental Evidence on Portfolio Size and Diversification: Your
Mileage May Vary … A Lot.

5. Friesen, G., & Viet, N. (2018). The Economic Impact of Mutual Fund Investor Behaviors.

6. George, C. (March 2006). Hybrid Mutual Funds and Market Timing Performance. The Journal of Business, 79(2), 771-797.
 ELSS Mutual Fund preferences of Indian Tax Savers 5

7. Junhua Lu, J. (May 2007). How much is enough? Diversification across mutual funds.

8. Kosowski, R. (November 2001). Do Mutual Funds Perform When It Matters Most to Investors ? US Mutual Fund
Performance and Risk in Recessions and Booms 1962-1994. Financial Markets Group, London School of Economics.

9. Krishna Kumar, K. (August 2016). Evaluation of Investment Performance and Perception of Investors in Bengaluru and its
Sub-Urban Area with respect to Equity Linked Savings Scheme Plans of Indian Mutual Funds (Doctoral Thesis). Retrieved
from https://iujharkhand.edu.in/KKrishna-Kumar-Thesis.pdf

10. Ministry of Finance, Govt. of India. (2005). Equity Linked Savings Scheme, 2005 Notification No. 226/2005, dated 3-11-2005.
Retrieved from https://incometaxindia.gov.in/Communications/Notification/920110000000001519.htm

11. Oliver, G., Ralf, G., & Ramun, D. (May 2015). Size Matters – Small is Beautiful: The Impact of Portfolio Diversification and
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12. Satya Sekhar, G. (2013). Role of Indian Mutual Funds in Financial Inclusion: Public Vs Private Sector. Journal of Business
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13. Sebastian, M., & Martin, W. (February 2010). Financial Literacy and Mutual Fund Investments: Who Buys Actively Managed
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14. Tripathy, N. (July 2014). An Empirical Analysis on Performance Evaluation of Mutual Funds in India : A Study on Equity
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15. William, G., & Andrew, A. (September 2014). Effects of Income Tax Changes on Economic Growth. Economic Studies at
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16. William, N., Massimo, M., & Rouwenhorst, K. (n.d.). Behavioral Factors in Mutual Fund Flows.

17. Yonathan, S., & Farmery, J. (2010). What drives mutual fund asset concentration?

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