The three popular categories of equity funds—
Equity-linked savings scheme (ELSS),
Sectoral Funds and
Thematic funds
ELSS. Like any diversified equity MF, it routes your investments into the equity market. However, certain ntrinsic features set it apart from a normal MF: the amount invested in an ELSS gets tax benefits, and so the funds invested in an ELSS have a lock-in period of three years. Investment in ELSS up to `1 lakh, under Section 80C of the Income Tax Act, 1961, reduces the gross total income by an equal amount, thereby reducing the tax liability. Any income in the form of dividends received from an ELSS fund is tax-free in the hands of the investor. Even the long-term capital gains arising from the transfer of such ELSS units is tax-exempt. The lock-in feature lends an element of stability to ELSS portfolios. With corporate money kept out, these schemes do not have to deal with sudden, large-scale redemptions. As a result, ELSS tends to have a corpus that is more stable and of an optimum size, which encourages good fund management. The fund manager can take a medium- to long-term view on certain stocks, which helps in improving returns. The 3-year lock-in period inculcates investor discipline.
The performance of an ELSS may vary from that of a diversified fund, usually due to different management styles and the market's rewards for a particular style at a given point in time. ELSS schemes may have a small- and mid-cap bias. Fund managers may like to take advantage of the 3-year lock-in period to exploit value stories in various sectors. If your objective is to be invested for the long term and also save some taxes along the way, ELSS schemes could be a good bet. Thanks to the equity exposure, ELSS is one of the few options available for tax benefits under Section 80C that has the potential to deliver highest inflation-adjusted returns.
