* The rate on fixed income options has fallen sharply in recent times. In this years Budget, the interest rate on saving instruments such as public provident fund (PPF), national saving schemes (NSS), national saving certificates (NSCs) has been reduced by 1 per cent, thus making a strong case for investing in tax-planning funds.
* Equities prove to be the best performing long-term asset class and, hence, the best hedge against inflation. And as the equity market is currently attractively valued, theres no better time than now to start investing in equities together with tax plan so you wont miss important opportunities like this to trim your tax bill.
However, investors need to remember that as these schemes invest in equities, they are riskier than other tax-saving investments. For instance, the category was down 19.48 per cent in 2001 but gained 16.87 per cent the following year (in 2002). But tax-planning funds, apart from providing tax benefit, also serves the purpose of long-term investing as it carries a lock-in of 3 years.
Tax-planning fund entails an investor 20 per cent tax rebate for investment upto Rs 10,000 a year for an individual earning upto Rs 1.5 lakh under Section 88 of the Income Tax Act. And for those individuals falling in the income bracket between Rs 1.5 lakh and Rs 5 lakh, the rebate is 15 per cent.
Though, in Budget 2002-03, this rebate has been removed for high-income individuals (earning over Rs 5 lakh a year), they still remain one of the better tax-saving options for middle-class individuals. Currently, there are 18 open-ended tax-planning funds with a total asset base of Rs 350 crore as on April 30, 2003. Despite tax benefits, this is the smallest category of funds in India on account of the largely retail base.
A tax-planning fund is essentially an equity-diversified fund. However, tax-planning funds performed better than pure equity diversified funds both in 1999 and in 2000. In 2001 and 2002 though, both these categories were neck in neck.
Since tax-planning funds have a three-year lock-in period, it gives greater room to fund managers in making big sector bets. Consequently, majority of these funds are relatively more volatile than their equity-diversified peers. But this should not be a cause of worry as over the long-term, the returns get smoothened. Another important thing to note here is that funds in this category do not maintain a high cash exposure.
The three-year lock-in gives the fund manager greater flexibility to make investment decisions. Thus, as these funds usually are not susceptible to a huge redemption, they are not required to hold huge cash.
In the past five years, tax-planning schemes have posted an annualised average return of 12.17 per cent, as on May 15, 2003, far better than what the Sensex managed (-4.78 per cent). And even in the trailing three-year period, when the markets have been down, the category outperformed the Sensex by 4 per cent, as on May 15, 2003.
Most tax-planning funds have been strong believers in large-cap stocks. However, a few like Libra Taxshield, Magnum Taxgin and HDFC Tax Plan have a bias towards mid and small-caps. Initially, Birla Equity Plan courted large-caps but since mid-2001, it has been chasing mid-caps and small-caps.
Thus, during the recent rally in mid-caps, these mid-cap-tilted funds have done better than the rest. For example, through 2002, HDFC Tax Plan gained 42.61 per cent whereas the category was up 16.36 per cent. In contrast, funds like Zurich and Alliance, which have heavy large-cap concentration, underperformed the category with a return of 13.09 per cent and 15.37 per cent, respectively.
This year, in 2003, Birla Equity Plan and HDFC Tax Plan 2000 is leading the pack of tax-planning funds - up 12.9 per cent and 12.33 per cent, respectively as on May 15, 2003. This is largely on account of the funds substantial exposure to mid-cap stocks - the S&P CNX Mid-cap 200 index is up 6.8 per cent while BSE Sensex is down 10.8 per cent this year as on May 15, 2003.
Despite this, the large-cap dominated Zurich India Taxsaver - a 5-star fund -- is up 11.1 per cent on the year-to-date basis as on May 15, 2003.
The funds higher exposure in financial sector stocks -- 24 per cent, as on April 30, 2003 -- has worked in its favour.
However, another five-star fund, Alliance Tax Relief 96s higher technology exposure (average 27 per cent in 2003) has landed it in the middle of the category. The BSE IT Index is down 18 per cent in 2003 as on May 15, 2003.
The Right Strategy
If you want to convert your tax-saving investments into a sizeable nest egg, consider a long-term investment in a tax-planning equity fund upto the Rs 10,000 limit and look beyond the three-year lock-in.
Besides, the tax-planning equity funds also facilitate regular investment-every month or quarter, rather than waiting till the end. By spreading your investments over a year, you ride out the ups and downs of the stock market. Finally, take your pick from the well-diversified tax-planning funds, think long-term and follow a disciplined strategy to invest regularly and stay invested in order to increase your wealth.