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Getting Over the Top

The financial year is about to end and it is time to finalize to invest in certain mutual fund instrument where tax saving is the most but it is better to know how the tax- saving funds operate and It is not difficult to choose amongst the mutual fund for investing purpose but mostly investors choose a fund based on its performances but there is more to the funds than the past of the funds, one must know where the fund fits that is the risk appetite or the large size of the portfolio. Most tax savings funds invest in the small caps and mid caps when the portfolios are overloaded with these stocks which make the returns volatile. Some opt for taking the aggressive cash calls that is hold a big cash if the stocks are a bit expensive and some opt for churning the portfolios.

Mostly the tax saving funds buys a mix of large and small cap companies in certain ratio of exposures usually around 60% of the exposure in large caps and rest in middle and the small caps because the prices in the mid and the small caps are more volatile as compared to the large caps.  If one takes a look at the turnover ratio of any given portfolio it shows how fast the fund churns the portfolio for example a hundred percent portfolio implies that the portfolio has changed completely in one year, and a 25 % figure indicates that the change in the portfolio happens in four years. Another methodology is to sell the expensive stocks or sectors and buy relatively cheaper stocks or the sectors that is in other words simply capturing the inter and intra sector valuation differences. A big churn usually means some extra costs all due to securities transaction tax although there is a cap on the fee which the mutual funds can charge from the investors, and mostly the expenses are more a function of assets under management rather than the turnover ratio, but a high turnover ratio only indicates an aggressive fund management. The reason for keeping so much cash is the discipline factor and the scheme sells the stocks only after the schemes cross the pre-determined limits, whenever there is correction in the market the opportunity is ripe to deploy the cash. There are only few fund managers who take the aggressive cash calls most of the cash is fully invested just a few is kept aside to meet the liquidity needs and for restructuring or re-balancing of the portfolio.

Another factor is the standard deviation which helps only in measuring the volatility in returns. The volatility may be high all due to the composition of the portfolio, high exposure to the small caps, mid caps and the cyclical stocks too and very active churn, where as the standard deviation shows how much deviation of the returns from the usual average for example if the average return is 60% and the standard deviation is 20% than the one return of the one year will be 40 to 80%, the more is the standard deviation the more it implies of the higher volatility.

To analyze the fund management style one has to first of all select a tax saver fund which can be broadly put into three categories aggressive, moderate (equity) and the conservative (equity) on the pre discussed parameters. And there are precisely 38 open-ended tax-saving funds also commonly called Equity Linked Savings Schemes (ELSS). So to conclude here it always makes more sense in picking funds from the aggressive and the moderate categories as the conservative funds are laggards if we go by their ratings. So a fund mix and match of aggressive and the moderate category is better in the long term. If we analyze the market caps the large cap compromises of top 80% stocks, and those stocks whose total market cap accounts to the next level 15% of the BSE traded companies, the small caps usually account for the last 5% of the BSE traded companies. But at these times when the equity markets are performing pretty well than as an investor funds with the higher exposure to the midcap and the small caps stocks tend to perform well too and naturally the investors are easily attracted towards them and the market may go in for some correction is the last thing in the priority of any investor or rather they tend to forget the word such as market correction. So to it play safe one must go for the combination of aggressive as well as the conservation funds or choose a fund with a relatively lower exposure to the mid caps and the small caps which will keep you in a win win situation.