The Three Year Magic of ELSS

Equity Linked Savings Schemes(ELSS) as a class was ushered in by budget for fiscal 1990-91 with provision to deduct a maximum of Rs 10,000 invested in a specifically designed Mutual Fund scheme from Income taxable under Sec 80CCB of Income Tax act 1961.

The PSU Mutual Funds led by Unit Trust of India offered MEP 91, Canpep 91 from Canabank MF, Dhan 80 CCB (1) -Cum from LIC MF and Magnum Equity Linked Scheme '91 from SBI MF and PNB ELSS 91 from PNB MF were the pioneers in ELSS world.

MFs were to invest predominantly into equity normally 80% of its portfolio. In that respect, they as a class reflect diversified equity funds. Such schemes allowed deduction of investment amount maximum of Rs.10,000 under Sec 80 CCB of Income Tax Act 1961; after the lock-in period of 3 years, the investor can repurchase at whatever NAV of the scheme although the scheme had a maturity period of 10 years. When such repurchases were effected, the initial amount invested was considered as income of that year and taxed. The capital gains portion were also appropriately dealt with. Even if there was a capital loss, mandatory tax amount was deducted at source. That made investors learn that MF products could be risky.

Fiscal 1991-92 also had the same features. Any dividends there upon continued to be for exemption under 80L of Income Tax Act 1961.

But from next fiscal, the story was re-written all over again by the govt moving the ELSS to Sec 88, thereby enabling tax rebate 20%. Investors having income more than Rs 5 lakhs were not permitted in this route. The UTI kept their winning sales series name Master Equity Plan and launched MEP93. The underlying character of the product changed, but the name continued. This created irritations as investors in MEP91 expected same treatment in MEP 92 and 93 when they simultaneously repurchased these schemes after the lock-in-period. The Closed end schemes got notified every year as an asset class eligible for Tax rebate.

The total Collections in 1991-92 were Rs1995.50 crores which touched Rs. 100.60 crores in 1996-97 from all ELSS sold.

The learning made law makers and MF industry wiser by 1998 to amend ELSS 1992 permitting MFs to launch Open ended variety. It had the following advantages:
No launch expenses every year.
All around the year they can sell &
The investor can SIP the investment spread according to his salary
No year end pressures on the investor &
No sales overdrive in February -March by MFs

UTI launched its ETSP as an Open ended Scheme. The section provided 10,000 for ELSS, 30,000 for Infrastructure bonds and an overall limit of 70,000 for other listed items under Sec 88.

In 2003, UTI MF clubbed all five of their MEPs into a separate scheme called MEPUS from MEP93 to MEP97 into one single scheme giving option to unitholders for exit. 95% conversions were procured and no fresh investor allowed in. This was a strategic decision by UTI MF as the mandatory lock-in-period has been over, they could enhance fund management by this kind of a consolidated move.

The stock market fluctuations affect the market value of ELSS investments. As on 31 March 2004, the AUM stood at Rs 1669 crores as against Rs. 3036 crores of 31 March 2000.

From 1 April 2005, sec 80 L which gave exemption for divdidends from units ceased to exist. And the ELSS got shunted to Sec 80 C from Sec 88 making it as a closed end affair. This was freeing the individual to decide where he wants to invest and how much, instead of Govt. deciding where the tax payer's money should be invested; But there was panic in the industry as the notification mentioned the effective date as the date of notification rather than 1 April in the case of ELSS. This meant that schemes in force from 1 April 2005 to date of notificateion ie.. 03 November 2005 may not be covered under the scheme. This was subsequently clarified that they also would be covered under the new scheme.

By December 20, 2005 another clarification also came from Govt. that a MF can have one epen end scheme with prior approval of SEBI and in such cases the 'year' would be calculated from the date of purchase. This give the much awaited flexibitlity of SIP under an ELSS throughout the year.

It provided clear cut instructions about eligible investments, limits on aggregate investments in each class of assets and stipulated a maximum time of 6 months from the date of closure of sales to achieve the eligible investment criteria. UTI turned in another series of ELSS called UTI Long Term Advantage Fund

The fiscal 2007-2008 saw clubbing of 5 year bank deposits also into the Sec 80C overall limit of 1,00,000 brought in fierce competition to some extent freezing the movement of funds from banks to mutual funds.

The fiscal 2008-2009 ushered in payments for reverse mortgage into the same kitty of 1,00,000 increasing the choices further in this class.

In the overall limit of Rs 1 ,00,000 ELSS clearely scores on maturity period over the 15 year PPF, 6 year NSC and 5 year bank deposits. One do not loose any growth prospects, if not re-purchased on the completion of 3 years lock-in-period in an OES. You can thus plan your entry as well as exit.

Although they have fixed rates of interest and that are assured over the period, in the case of ELSS the returns are market related.

The risk in the case of bank deposits are determined by the capital adequacy of the bank. The AUM of ELSS has increased 3.8 times from 1727 crores in 2004-2005 to Rs 6589 crores in 2005-2006. Further to Rs.10,211 crores by 2006-2007 and Rs. 16020 crores as at 31 March 2008. That is almost 9.3 times growth in a span of 4 years.

SBI MF, Franklin India MF, HDFC MF, UTI MF are formidable presence in this class. Reliance MF has made history in terms of AUM, but the performance is under testing as yet to complete 3 years. So far only three funds have crossed 1000 crores in AUM from this class apart from Reliance: They are SBI Magnum Tax Gain and HDFC Tax saver.

The product differentiation available under ELSS beyond the plain vanilla schemes are indexing and using quantitative methodology.

Franklin India Index Tax Fund has not gained in AUM as other schemes of the fund. Lotus india AGILE Fund follows quant route to generate returns.

Product Differentiation in the Debt Mutual Funds

From mere Assured Returns of 1970-1990s, the debt funds found themselves emerging as MIPs without assured returns led by Birla Mutual Fund, ICICI Pru etc.. during the early years of opening up of the industry to private players. MIPs offered a certain periodic cash flows at predetermined frequencies(Monthly, quarterly, half yearly and annally).

Money Market Instruments like Certificate of Participation, Certificate of deposits and Interbank Participation Certificates got introduced in 1988-89. Side by side another class evolved the Money Market Mutual Funds (April 1992) . Private Sector was allowed to launch MMMFs by 1995-1996. UTI News, October 1996 has a mention that MMMFs as a class has gained popularity and tehy would also like to introduce the same shortly. But the first AMFI newsletter October1998 has not captured this as a separate class, though the ELSS has been recognized. But there is a mention that cheque writing facility has been granted for MMMFs in the Newsletter dated April 1999 that such cheques would not have the characteristics of the negotiable instrument.

By1999, bond funds drifted silently to the maturity matching versions of MIPs called serial plans. Kotak Mahindra Mutual fund was th efirst to have this in their fold, soon copied by others like Dundee, Sun F&C and Prudential ICICI with maximum maturity of 3 years, such schemes subsequently got legalised as Fixed Maturity Plans(FMPs). They gave safety of bank FDs and ease of Current Accounts simultaneusly. Probably the parenthood (Bank , FI sponsored MFs) had a bearing on designing new products. Cash rich Institutions and Companies in fact were holding major chunk in such schemes. SEBI intervened to wipe off solitary member schemes by 2003.

Income Distribution Tax on schemes with less than 50% exposure to equity was imposed in 1999 @ 11% and then hiked to 22% in 2000-2001. By 2005-2006, the FMPs were fully established. Even today the FMPs score over conventional FDs on several aspects.

In 1998 RBI cleared the way for Gilt Funds that primarily invested in govt paper and Kotak Mahindra Mutual Fund took the credit for pioneering it in 1999 .Today we have both short term and long term gilt funds.

In February 2002, SEBI permitted MFs to invest 4% of their Net Assets in high quality, convertible currency, Govt/Non-Govt instruments subject to maximum of $50 million. This opened a new world of opportunities. Franklin India International Fund (Dec 2002) is an example.

There is Debt Funds that specialise in Corporate Debt paper. ING Select Debt Fund (Sep 2004) is such one.

Debt Funds in General can be classified into 3 groups:
1. Passive Funds (Income and gilt funds) do well in the falling markets
2. Active Debt Funds (also called Dynamic funds) do well in a volatile market and
3. Accrual Funds(Other wise called Floating Rate Funds, Liquid funds) do well in a rising market
They give best results in the respective market condition. But Indian markets saw
Standard Chartered All Seasons Bond A (Aug 2004) is an Fund of Funds that has been designed to perform in all the three market conditions.

When derivatives were opened for MFs, Arbitrage Funds found their way into the market. The first such fund was offered by M/s. Benchmark AMC. The Benchmark Derivative Fund with a self imposed AUM of 100 crores was launched in Dec 2004. The corpus limit lifted by 26 April 2005.

Debt Funds started declaring dividend(income distribution) at chosen intervals otherthan the traditional monthly, quarterly and annual versions climbing the waves of tax-free dividend(income distributions). The liquid versions with floating interest rates linked to PLR of a chosen bank, MIBOR or LIBOR, CRISIL Balanced Index etc.. started filled the vaccum.

By Mid 2005, we find a lot of interval funds coming to the market. The CPOSs got christened by SEBI in August 2006.

As more and more interval funds started coming, the fund houses recognized that they can save on OD filing fees and attended procedures of FMPs. The first of its kind came from HDFC Quarterly Interval Plan A(March 2007). Investor anyway gets the benefit of enhanced returns resulting from the hedging strategies. Also the subscription and redemption intervals are fixed. Investors were aware of the additional risk of the market expectation that the fund manager undertakes in creating that extra. So FMPs continued to exist with 1 month, 90 days, 180 days, 366 days 550 days etc.. helping investors to reduce Interest Rate Risk.

When SEBI noticed that the FMP funds were primarily finding deployment in Bank FDs in an urge to improve AUM, 15% cap was installed on such temperoray fund allocation by MFs.

The old fashioned MIPs without Assured Returns shrink in AUM. Total AUM of the 31 MIPs stood at 2923.57 crores as at 31 March 2008. Except the HDFC MF, no other fund house got a MIP of decent size by 31 March 2008.

2008 saw the Equit Index Linked editions of FMPs with ICICI Pru taking the lead.

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