ith options ranging from PPF and NSC to insurance policies, pension funds and infrastructure bonds, one product stands apart.

The Equity Linked Tax Saving Schemes offered by mutual funds not only give tax concessions, but also earn handsome returns. Let's find out why they make sense.

• Smart tax-saving solutions

The best of both worlds

ELSS are the mirror image of diversified equity funds. That means the fund manager will invest in shares of various companies across various industries. There is the added tax benefit which a normal diversified equity fund will not have.

Under Section 88 of the Income Tax Act, you can get a tax rebate on investments in tax planning investment schemes. Investments in tax planning equity funds is limited to Rs 10,000 per year. This may not save much tax but over the long haul, these funds can generate huge returns and actually result in decent savings.

Not convinced? Look at the returns.

In the three years ended February 7, 2005, tax planning funds generated 42.58% annualised.

Since they invest most of their money in equities and equity-related instruments, this is a more risky tax saving option compared to the others.

Why ELSS?

These funds have a lock-in period of three years. Much better when compared to the lock-in periods of four and 15 years of NSC and PPF respectively.

The dividends earned will be tax free. When you sell the units of these funds, you can avail of the long-term capital gain for which there is no tax.

View the three year lock-in period as a benefit. Because when you invest in equity, you must take a long-term view. The real potential of equities starts to show only after a few years. This allows you to ignore the short-term slumps and stay invested for the long haul.

Also, the lock-in gives fund managers the freedom to take sector and stock bets, which they are not able to do in the regular equity schemes.

Which one should you pick?

Before we go on to that, we would like to explain a term: market cap. You will come across it quite often as we talk of fund managers investing in large cap, small cap and mid cap.

Market capitalisation = Market price of the share x The number of shares in a company

Large cap = Companies with a market cap of over Rs 1,500 crore (Rs 15 billion) 
Mid cap = Those between Rs 25 crore (Rs 250 million) and Rs 1,500 crore (Rs 15 billion)
Small cap = Those less than Rs 25 crore (Rs 250 million)

Franklin India Taxshield
NAV on February 18, 2005: Rs 67.93

There's a good reason why this fund is still the largest in the tax planning category despite an average performance in the recent past. It has a great long-term performance, a focused approach and a large-cap orientation. It has kept away from the dangerous charm of mid- and small-cap stocks. This is why it has failed to match the returns of some of its aggressive peers.

The fund has largely followed a buy-and-hold strategy. For instance, ITC, HPCL [Get Quote], SBI [Get Quote] and Infosys [Get Quote] have found a permanent place in the portfolio since 2000.

The fund may not look flashy right now, but it is definitely a matured player.

HDFC [Get Quote] Long Term Advantage
(Earlier HDFC Taxplan 2000)
NAV on February 18, 2005: Rs 48.517

The fund's outstanding performance over the long term has seen its corpus (total portfolio) increase 12 times in the last two years.

Starting as a large-cap oriented fund, it soon realised the potential of mid- and small-cap stocks and increased weightage to these two types of stocks in August 2002. The fund ended that year as the hottest fund in the category.

The exposure to these two sectors increased to over 80% in 2003 and 2004 and ended the two years as the third best performing fund in the category.

Overall, the fund is a strong contender for one's portfolio.

HDFC Tax Saver
NAV on February 18, 2005: Rs 66.284

You can't afford to ignore this fund. An ability to perform in a booking market and guard the gains in testing times makes it special. It demonstrated its real worth in the bearish markets of 2000 and 2001 when the market slumped.

The fund ended 2000 with a gain of 5.74% when the average losses of its peers was 22.58%.

The year 2002 was the only tough patch in the otherwise sparkling track record of the fund. But the fund has never since looked back. Exposure to mid- and small-caps has gone up 43% in December 2003 to 71% in December 2004.

HDFC Tax Saver deserves a position in all equity portfolios.

Prudential ICICI [Get Quote] Tax Plan
NAV on February 18, 2005: Rs 46.92

Though this fund has been one of the most volatile in the recent past, it has rewarded its investors quite well.

It has been extremely lucky with its stock selection.

The fund manager takes long-term calls and bets on small- and mid-caps, which provide better returns than large-caps, although the risk is higher. So far, the stock picking has been impressive.

For investors, volatility remains an issue, but it could even out over three years.

This fund deserves a second look.

Sundaram Taxsaver
NAV on February 18, 2005: Rs 13.6113

Earlier, Sundaram Taxsaver was a conservative player and a middle-of-the road performer.

It would neither zoom exceptionally in rising markets, not tank in bad times.

But things changed after December 2003. The fund increased its exposure to mid and small caps considerably. It has since maintained an average 66% allocation to them -- and the result is evident in the fund's performance.

The fund is now one of the most volatile in this category. But with no single stock crossing 5% of the portfolio, diversification would take care of the excessive volatility.