Return Tracker. Face-off: Diversified vs ELSS funds

Many investors have seen their portfolio erode sharply as the markets tanked around a fifth on global growth worries in the first two months of this year.

Although the market has rallied since then and is at an eight-month high, a spurt in volatility can hurt investors who tend to act in haste.

This volatility, however provides both opportunities and challenges to fund managers — opportunities in stocks that are available cheaper; and challenges in dealing with sudden outflows.

Fund managers of equity linked savings scheme (ELSS) seem to be relatively better placed to manage a spurt in outflows than their diversified cousins.

Thanks to the mandatory three-year lock-in period, the fund manager, in theory, has an inherent flexibility to invest with a longer horizon. But has this theory worked in reality?

We compared 38 equity diversified schemes and 16 ELSS schemes both with a common benchmark — the S&P BSE 200.

Surprisingly, over one, three and five-year periods, there isn’t much divergence in the average returns delivered by these two fund categories. For instance, three-year average returns from diversified equity schemes stand at 21.5 per cent and that for ELSS schemes works out to 21 per cent.

Over a longer five-year period, ELSS schemes marginally outsmarted diversified schemes — annualised 13.4 per cent returns versus 12.2 per cent.

But averages can be misleading as they hide the stark divergence in returns of the top performing funds within each category.

The top five schemes from the diversified pack trounce top five ELSS schemes by over 5 percentage points over a three-year period.

While chart toppers in the diversified category delivered 30.1 per cent returns, top performers among ELSS schemes managed a lower 24.5 per cent return.

Over a longer five-year period, top five diversified funds delivered 17.2 per cent returns against ELSS’ 15.9 per cent gain.

So which category of fund should one opt for?

While there are many products that offer tax breaks under 80C, if you seek equity exposure, ELSS may be the way to go.

Over a 10-year period, returns are in the 13-14 per cent range. Lock-in is also relatively shorter at three years, than other fixed income options such as PPF or NSC. But if you have exhausted your tax exemption limits and have surplus which you wish to invest in equities, then quality diversified equity funds may be a better choice.

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