Launched in March 1996, Principal Tax Savings is an open-end equity tax planning fund, having lock-in period of 3 years. The fund seeks to build a high quality growth oriented portfolio to provide long term capital appreciation through investment primarily in equities. Entry load is 2.25%. Minimum investment is Rs 500.

Fund Portfolio

The fund aims at investing 80-100% in equities, 0-20% in Debts and other holdings. As on December 31, 2007, the asset allocation was - 96.14% in equities while other holdings accounted for 3.86%. As far as sectoral weightings are concerned, Metals and Metal product lead the race with 17.07% of assets allocation, Financial services accounts for 13.02%, Services 11.10%, whereas, Basic/Engineering and Technology sectors account for 10.47% and 9.65% respectively. Godrej Industries is the top holder at 5.68% followed by Adhunik Metaliks (5.64%) and United Brew (4.53%).

Despite a well balanced portfolio, Principal Tax Savings is more daring than most members of its group, as majority of its investments focuses on small-cap equities. As on December 31, 2007, small-caps accounted for 39.16% of its assets holding.

Fund Performance

The fund has performed handsomely over the period, posting annual returns of 80.81% and 43.36% for 2007 and 2006 respectively. As of Jan. 25, 2008, 1-yearly returns stood at 40.38% (against category return 32.70%), 2-yearly returns were 41.25% (against category return 29.56%), 3-yearly and 5-yearly returns were 48.87% and 53.16% respectively against category average 41.23% and 48.84%.

The fund has a beta of 0.88 (an indicator showing high returns). The Sharpe ratio stands at 1.82. Net assets have climbed to Rs 350.49 crore as at December 2007.

Commenting on the investment philosophy, Mr. Shyam Bhat, senior Fund Manager, says that the company has a bottom-up stock-selection approach and not a top-down / industry-specific strategy for the Fund. The stocks that are undervalued from a long-term perspective are selected without any industry/market-cap bias. The focus is on those companies that can show above-average earnings growth for the next 3 years, have a strong competitive position in their respective industries and have the financial strength to execute their business strategies.

The fund has an aggressive approach in churning of portfolio. Out of total stocks held, top 5 stock accounts for 24.29% of portfolio. The top five stocks in the portfolio as at Dec. 31, 2006 are Godrej Industries, Adhunik Metaliks, United Breweries, Grasim Industries and Balaji Telefilms. The top three sectors accounts for about more than 40% (41.19%) of the portfolio.

When queried by myiris, this is what the fund manager had to say about the prospects of the sectors in the fund's portfolio; "We are particularly positive on metal & mining companies which have an access to natural resources (coal/iron ore/zinc, etc) as our view is that there could be scarcity in this space in the longer-term. We are positive on the domestic capex and consumption-driven growth, and therefore we have a high weightage in construction & capital goods, and banking & financial services sectors. In this backdrop of heavy infrastructure spending, there is a considerable opportunity for construction companies in India. The order backlog is robust, with newer contracts coming in at higher margins due to the scarcity of contracting capacity. We could see margin expansion in this sector over the next couple of years, on account of better pricing as well as softening of interest rates from current levels".

When asked whether investing major chunk in small-caps is risky bet in a tax saving fund, Bhat said, "Our competitive advantage lies in primary research, i.e. identifying stocks which are not widely researched by analysts from the broking side. Many of such stocks happen to be in the small-cap or mid-cap space. However the Fund is open to investing in large-caps as well, particularly if they are undervalued. Considering that a tax-saving Fund is one where there is a lock-in of 3 years for each investor, it is ideally-oriented for this strategy (as good quality small/mid-caps with a high growth potential could do well over a 3-year period, even if they may tend to be volatile in the shorter-term)."

The Principal Tax Savings fund has been a consistent performer since its launch. The fund has consistently beaten the category average over the one-year, three-year and five-year period. But with a high concentration on small-caps, investors should expect some nasty surprises.