Parag Parikh ELSS Tax Saver Fund underperforms benchmark for 3 years despite 5-star rating. Should investors worry?

Mutual fund investors often rely on benchmark returns, ratings and research recommendations to assess whether a scheme deserves a place in their portfolio. But what should investors make of a fund that has consistently lagged its benchmark over multiple periods, even as research platforms continue to rate it highly?

Two investors who reached out to ETMutualFunds flagged that Parag Parikh ELSS Tax Saver Fund has underperformed its benchmark over the one-, two- and three-year periods, raising concerns about its investment strategy and whether they should continue to consider the scheme. The concerns come even as research platform PrimeInvestor has assigned the fund a five-star rating and a Buy recommendation.

The two investors seek advice on how significant is sustained 1-, 2- and 3-year benchmark underperformance when evaluating an actively managed ELSS fund, are there specific reasons in the fund's current portfolio, strategy or investment approach that could justify continuing to prefer it despite this underperformance and would one consider the recent underperformance within the normal range for this strategy, or is it something that should make investors question the fund's investment case?


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Vishal Dhawan, Founder and CEO of Plan Ahead Wealth Advisors told ETMutualFunds that investors should assess such underperformance in the context of the fund's investment style, portfolio positioning and performance across market cycles, rather than relying solely on trailing returns.

How significant is three-year benchmark underperformance?

According to Dhawan, underperformance over one-, two- and three-year periods is not unusual for actively managed equity funds. Returns over fixed periods can be influenced by prevailing market conditions and shifts in leadership between investment styles, such as growth and value.

For an Equity Linked Saving Scheme (ELSS), which comes with a mandatory three-year lock-in for each investment, Dhawan says investors should ideally evaluate performance over a full market cycle of five to seven years.

However, a three-year period of underperformance warrants closer examination. Investors should assess whether the fund's investment process remains consistent and whether its portfolio positioning explains the performance gap, instead of automatically concluding that the strategy has failed.

Why has the fund lagged its benchmark?

Dhawan points to the fund's relatively high large-cap allocation and valuation-conscious investment approach as possible reasons for its recent performance.

The fund maintains an allocation of approximately 65% to 70% in large-cap stocks. When mid-cap and small-cap stocks drive broader market gains, a portfolio with substantial large-cap exposure may lag indices that benefit more from rallies in smaller companies.

The fund also follows a value-oriented approach, focusing on cash-generative businesses available at reasonable valuations rather than chasing stocks experiencing speculative momentum. Such an approach can underperform when expensive, high-momentum stocks lead the market.

Another factor is the fund's allocation to cash, cash equivalents or arbitrage instruments. While these holdings can help cushion losses during market declines, they can also drag on returns during sharp market rallies.

These factors provide a possible explanation for the performance gap, but investors should examine the latest portfolio disclosures and compare the fund with an appropriate benchmark and peer group before drawing conclusions.

Is the underperformance a concern for investors?

Dhawan considers the recent underperformance consistent with the potential challenges faced by a valuation-conscious strategy with a large-cap orientation. In his assessment, the fund's investment process has remained intact, and the recent lag does not by itself indicate that the strategy has broken down.

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However, he says investors should become concerned if the fund begins to deviate from its stated approach. Examples include chasing short-term momentum by buying overvalued stocks, making rapid changes to the portfolio to improve near-term performance, or failing to limit losses during broader market corrections.

Dhawan also points to low portfolio turnover, governance standards and adherence to valuation criteria as factors investors can monitor when evaluating whether the fund remains true to its investment philosophy.

What should investors check before making a decision?

A high rating or a Buy recommendation should not be viewed in isolation. Investors assessing the Parag Parikh ELSS Tax Saver Fund should consider these five points:

• Long-term performance: Compare returns over five- and seven-year periods and across rolling periods, rather than relying only on trailing returns.
• Benchmark and peer performance: Check whether the fund has lagged its benchmark and comparable ELSS schemes consistently.
• Portfolio positioning: Examine its large-cap allocation, cash holdings, sector exposure and stock selection.
• Investment-process consistency: Assess whether the fund continues to follow its stated value-oriented approach.
• Risk management: Review volatility, drawdowns and performance during market corrections.

Investors should also remember that ELSS investments are subject to a three-year lock-in for each investment, so the investment horizon and tax considerations matter when evaluating the scheme.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)

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