When it comes to tax-saving, ELSS or tax-saving mutual funds are among the most sought-after options. These funds not only offer tax benefits under Section 80C but also present the potential for wealth generation through market-linked returns. The growing popularity of ELSS mutual funds is evident from the sharp increase in their assets under management (AUM). In 2013, the total AUM stood at approximately ₹21,000 crore, but by 2023, it had surged to ₹1,89,000 crore, reflecting over ninefold growth in just a decade.

Understanding ELSS Funds

ELSS funds differ from other mutual funds due to their mandatory 3-year lock-in period. This feature ensures that whether you invest via lump sum or SIP, your money remains inaccessible for three years. As a result, choosing the right fund becomes critical, as you cannot redeem your investment during this period.

With 40 ELSS funds currently available, it may be overwhelming to decide on the best option. However, a methodical approach can help narrow down your choices. Here’s a structured evaluation of the top-performing ELSS funds for 2024 based on a variety of criteria.

Step-by-Step Fund Selection for 2024

1. Initial Screening Based on Long-Term Performance

Our analysis began by focusing on funds that have been in existence for at least seven years, as a strong performance record over time is essential to evaluate a fund's stability. Out of 40 available ELSS funds, 10 didn’t meet this threshold, so they were excluded from the analysis.

2. Rolling Returns: The Key to Measuring Performance

To assess the performance of the remaining funds, we calculated their 7-year rolling returns. Rolling returns offer a more accurate picture of long-term consistency by eliminating bias from single-point observations, as they capture performance across various market cycles. For this analysis, we used the average of 7-year rolling returns between December 2013 and December 2023, providing a balanced perspective on returns.

The top-performing fund in this analysis was Quant ELSS Tax Saver Fund, with average returns of 21.67%, while Nippon India ELSS Tax Saver Fund brought up the rear, with 10.35% returns.

3. Filtering Out Underperformers

We applied a further filter by removing funds that failed to deliver returns above the category average of 14.3%. This step eliminated 17 schemes, leaving us with 13 funds that exceeded the benchmark.

4. Consistency Matters: Quartile Analysis

Consistent performance is just as crucial as high returns. To evaluate this, we conducted a quartile analysis of yearly returns. The funds were divided into quartiles based on their annual performance, with funds in the first quartile (Q1) representing the top 25% in performance for a given year.

For example, Mirae Asset ELSS Tax Saver consistently ranked in Q1 from 2016 to 2021 but slipped to the third quartile (Q3) in 2022 and 2023. To ensure reliability, we kept only funds that remained in Q1 or Q2 at least 50% of the time. This led to the elimination of two funds, leaving us with 11 consistent performers.

5. Risk-Adjusted Returns: Sortino Ratio

To further refine our list, we analyzed each fund’s Sortino ratio, which measures risk-adjusted returns, with a focus on downside risk (negative volatility). A higher Sortino ratio indicates better risk-adjusted performance. This analysis revealed that the top performers included Quant ELSS Tax Saver Fund, Mirae Asset Tax Saver Fund, and Bank of India Tax Advantage Fund.

The Final Cut: Top ELSS Funds for 2024

After applying all these filters, the following funds emerged as the best performers based on our evaluation:

- Quant ELSS Tax Saver Fund

- Mirae Asset Tax Saver Fund

- Bank of India Tax Advantage Fund

These funds not only generated category-beating average returns but also showed consistency over time and delivered superior risk-adjusted performance.

Why Use Rolling Returns and Sortino Ratios?

Rolling returns offer a dynamic way to assess performance by calculating the returns at different points over a given period. This helps in reducing the effect of market fluctuations and gives a comprehensive view of the fund's long-term growth potential.

The Sortino ratio, unlike other risk-adjusted metrics such as the Sharpe ratio, focuses only on downside risk. This provides a clearer picture of how the fund performs when the market is under stress, ensuring that the investor’s money is not exposed to excessive risk.

1. Expense Ratio and its Impact

The expense ratio is the annual fee charged by the fund for managing investments, and even a small difference can significantly affect returns over the long term.

While selecting ELSS funds, one crucial factor is often overlooked—the expense ratio. It directly impacts your net returns because the lower the expense ratio, the more of your earnings you retain. For instance, a fund with a higher expense ratio might deliver a higher gross return, but once fees are accounted for, a fund with a lower expense ratio could provide a better net return. Among the top-performing ELSS funds, Quant ELSS Tax Saver Fund boasts one of the lowest expense ratios, enhancing its appeal for cost-conscious investors.

2. Fund Manager’s Track Record

Delve into the fund manager’s track record and their role in the fund’s performance. The manager's expertise, experience, and strategy play a pivotal role in the consistency of returns. Highlighting notable fund managers can add more credibility to the evaluation.

A fund is only as good as its manager. One of the distinguishing factors of the Mirae Asset Tax Saver Fund is the stellar track record of its fund manager, Neelesh Surana, who has been at the helm for over a decade. His disciplined investment approach, focusing on companies with strong fundamentals, has helped the fund maintain consistent performance across various market cycles.

3. Portfolio Composition

The Quant ELSS Tax Saver Fund has a diversified portfolio with a heavy allocation towards financials and IT sectors, which have been resilient and high-growth areas in recent years. Its top holdings include blue-chip companies like Infosys and HDFC Bank, making it a balanced choice for both aggressive and conservative investors.

4. Comparison with Other Tax-Saving Instruments

When comparing ELSS with traditional tax-saving instruments like PPF (Public Provident Fund) and FDs (Fixed Deposits), it becomes clear that ELSS holds a significant advantage in terms of return potential. While PPF offers a return of around 7.1%, ELSS funds have delivered 7-year rolling returns averaging between 14.3% and 21.67%. Although ELSS comes with market risk, its higher growth potential can far outweigh the fixed, low returns of PPF or FDs, especially for long-term investors.

5. Tax Treatment Post Lock-in Period

ELSS funds are subject to Long-Term Capital Gains (LTCG) tax of 10% on gains exceeding ₹1 lakh in a financial year.

After the mandatory 3-year lock-in period, ELSS investments are subject to Long-Term Capital Gains (LTCG) tax at a rate of 10%, applicable on gains exceeding ₹1 lakh per year. For example, if your investment appreciates by ₹1.5 lakh, only ₹50,000 will be taxed. This is significantly lower than the tax on other fixed-income instruments, making ELSS not only a tax-saving tool but also a tax-efficient one post-maturity.

6. SIP vs. Lump Sum Investment Approach

A SIP allows investors to mitigate market volatility by averaging the purchase price over time, while a lump sum could yield higher returns in a bullish market but carries greater timing risk.

Investing in ELSS funds through a Systematic Investment Plan (SIP) can help investors navigate market volatility more effectively than a lump sum investment. By investing small amounts regularly, SIPs reduce the risk of investing all at once when the market is at its peak. In the case of ELSS funds, each SIP installment gets locked in for 3 years, allowing for a staggered investment approach that can smooth out the impact of market fluctuations.

7. Historical Performance Across Different Market Cycles

During the 2020 market downturn, caused by the COVID-19 pandemic, the Mirae Asset Tax Saver Fund showed remarkable resilience by limiting its losses to under 15%, while many other funds in the ELSS category suffered larger declines. This ability to minimize downside while still capturing growth during recovery phases makes it a strong candidate for long-term investors.

8. Lock-in Period Benefits

While the 3-year lock-in period may seem restrictive at first, it can actually be a blessing in disguise for many investors. By locking in the investment, it prevents impulsive withdrawals during short-term market dips, giving the fund more time to ride out market volatility and deliver better long-term returns.

9. Impact of Market Conditions on ELSS Performance

ELSS funds, being equity-linked, can experience short-term volatility due to market conditions like rising inflation or geopolitical events. However, as seen historically, equities have outperformed other asset classes over the long term, making ELSS a robust choice for wealth generation. Investors should adopt a patient, long-term approach to fully reap the benefits of these funds.

Conclusion

ELSS funds provide dual benefits of tax savings and wealth creation. The 3-year lock-in can work in favor of investors who may otherwise be tempted to withdraw prematurely. In this analysis, the Quant ELSS Tax Saver Fund, Mirae Asset Tax Saver Fund, and Bank of India Tax Advantage Fund stood out as the top performers for 2024.

When choosing an ELSS fund, always consider not just returns but also consistency and risk-adjusted performance. You can utilize the ETM ranking to gauge the historical performance of these funds across multiple metrics, including recent performance.