Ritu Modi, Fund Manager – Equity of LIC Mutual Fund, talks about the current state of equity mutual funds in an interview with Outlook Money.

Why are there outflows in equity-linked saving schemes (ELSS) and equity-oriented schemes?

Equity markets have seen a roller-coaster ride in the last one year starting with one of the steepest falls and then achieving an all-time high. In the past few months, domestic mutual funds across categories have seen redemption pressure.

In the early days of the Covid-19 pandemic, there was a great deal of uncertainty that was created and led to sharp market corrections. Investors did not exit the market during the sharp fall and decided to wait and watch for a gradual exit. When the recovery mode kicked in, many investors who were waiting to exit started booking profits given the uncertainty.

Has ELSS become a less attractive avenue for investors?

ELSS qualifies for tax exemption of up to Rs 1.5 lakh under Section 80C of the Income Tax Act. Inflows typically happen in last quarter of the year when all the tax planning takes place. The Union Budget 2020 introduced a new optional tax regime which does away with most of the tax deductions, including the one available on ELSS investment under Section 80C of the Income-tax Act. Post demonetisation, ELSS saw largest inflows and good growth momentum. Given the economic uncertainty due to the pandemic and completion of lock-in period, investors preferred to shift out of these schemes and created liquidity.

When can one expect a turnaround in equity outflow?

The recent outflow from equity mutual funds is largely driven by a mismatch between the return expectations of investors and actual returns. The Indian equity market has been through a painful period of slower economic growth which had impacted the overall corporate earnings momentum. Slower earnings growth trajectory in the last five years have impacted the equities returns. Now we are in the initial signs of improvement in corporate earnings cycle driven by economic activities. As the earnings cycle picks up, equities as an asset class, may also deliver higher returns in the medium term – matching the investor expectations or even surpassing it. We believe this should be the key trigger for turnaround in the equity outflows.

What is the importance of ELSS in an investor’s portfolio?

Among most of the options available under 80C, ELSS funds are one of the most likely and cost-efficient investments which may generate higher inflation-adjusted return for a longer period of time. A 15-year history depicts Indian equities delivering 15 per cent compounded annual growth versus high single-digit returns from other investment avenues. An investor should note that short-term performance may be an aberration, but in the long term, each asset class has delivered returns in line of its characteristics and attributes. The investors should also take into consideration the effect of compounding in the long term where even a slightly higher returns versus others can create a huge difference in the long term.