THE coming few months will see the relevance of a category of mutual funds coming to an end. This category is the equity linked savings scheme, also known as ELSS, because the introduction of the Direct Tax Code (DTC) will leave no room for its existence as a tax-savings instrument.
The question that investors have to deal with is what they should do with their existing investments and how they will be affected if they put money into these ELSSs over the next few months. Let's take a look at the overall situation.
ELSS is a category of funds that provides a tax deduction for the investments that are made in the fund.
Under Section 80C of the Income Tax Act, there is a deduction of up to Rs 1,00,000 that is available for investments in various instruments and ELSS is one instrument that is included in the list.
The reason why several investors find this an attractive route to invest is that there is a tax deduction, and, at the same time, there is also the possibility of high returns from the investment. At present, this is the only route that provides a pure equity exposure to the investor in the tax deduction area. Now, with the introduction of DTC, which would be effective from the financial year 2012-13, there will not be any tax deduction benefit available for investments in such funds because the eligible instruments list does not include ELSS.
There is nothing very distinctive about ELSS due to the fact that they are exactly similar to diversified equity funds that are available in the market. The funds invest across a range of sectors and in several companies that stretch across market capitalisation, so they have the features of a diversified equity fund.
The only difference is that there is a tax benefit here and this separates the fund from the other schemes that are usually launched by mutual fund houses. Thus, when the tax benefit goes away, it will be difficult for the funds to actually get investments because there is nothing much in terms of its features that distinguishes them from the others.
Lock-in period: One of the main things that will actually protect investors in these funds is the three year lock-in period. Normally, when a fund loses flavour, the main way by which existing investors react is by pulling out the investments in the fund.
However, due to the fact that there is a three-year lock-in, this will not be easy as far as ELSSs are concerned because only those investors who have completed this time period will be able to take their money back. This will lower outflow and protect existing investors.
What will happen once the funds lose their tax benefit is that they will continue to run like before as there will be existing investors who will continue with the fund due to the lock-in provision. There cannot be a sudden windup of the fund because investors will have to continue with this fund at least till the time the lock-in period prevails.
After that, there can be different things that could happen, including winding up of the fund, but, what is important is the fact that investors should not worry about the fact as to what will happen about the continuation of the fund at least for the next three years.
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