Want to have your cake and eat it too? Buy into an Equity Linked Savings Scheme (ELSS).

What the scheme does for you is that it gives you a tax benefit upfront.

Add to that the gains you would earn in the normal course from investing in equities. And to top it all, there's no long-term capital gains tax or dividend tax.

The only downside, if you can call it one, is that there is a three-year lock-in period. That means you can't touch the money for three years.

The benefit would depend on the rate at which you pay tax. So for instance if you fall in the highest tax bracket of 30 per cent, you would gain Rs 3,000 immediately in an investment of Rs 10,000.

With the new Section 80C in place this year, you can now put more than Rs 10,000 into such schemes.

The performance of ELSS has also been something to write home about. They have topped the mutual fund equity category averages for the past three years (40.09 per cent) as well as the last two years (70.80 per cent).

Returns are not too different from those of diversified schemes. Of course, past returns are not always the best indicator of things to come, but fund managers believe that these schemes have some inherent pluses, the main one being the long -term nature of the scheme.

Says, Tushar Pradhan, senior fund manager, HDFC [Get Quote] Mutual Fund, "The freedom to invest for a longer term without worrying about a bad quarter here and there gives the fund manager more options that he might not have with an open-ended scheme."

Agrees Anup Bhaskar, head of equities, Sundaram Mutual Fund, "While identifying stocks, the strategy would be similar to the one adopted for diversified funds but the fund manager would not be in a hurry to sell or be forced to exit too soon."

Sandip Sabharwal of SBI [Get Quote] Mutual Fund points out that the average duration of funds tends to be around four years (a three-year lock-in is mandatory, and investors usually let the funds remain invested for another year) and, therefore, the turnover or churn is relatively less.

For instance, compared with a diversified scheme which has a turnover of say over 50 per cent, an ELSS sees a churn of just 20-25 per cent. "The impact cost for an investor becomes much lower," he observes.

Otherwise fund managers are looking pretty much for stocks with similar parameters as they would for diversified schemes. Says, Rajat Jain, CIO of Principal PNB AMC, "We run it like a diversified equity fund, with similar stock selection parameters, the quality of management, sound business franchise and valuations."

Adds Pradhan, "We are looking for growth-oriented businesses that deliver high returns on capital employed (ROCE) over the long term and undervalued stocks. The relatively much smaller corpuses of these schemes also help fund managers pick smaller cap stocks.

Explains Bhaskar, "We are able to buy into less liquid stocks since the assets under management (AUM) are smaller." The Sundaram Tax Saver invests in about 28-29 stocks but maintains a 7 per cent weightage per stock to limit the risk.

Compare the Franklin Taxshield with a corpus of just Rs 123 crore (Rs 1.23 billion) with the Franklin Bluechip, which is more than 10 times larger, with an AUM of around Rs 1,500 crore (Rs 15 billion). The average ELSS corpus is just about Rs 40 crore (Rs 400 million).