So long you had been busy keeping track of the mid-cap rally, inflation figures and interest rates. As March 31 approaches, there is another thought to keep you pre-occupied ? tax planning.

And if you are one such investor who loves the term ?equity?, then the instrument, which will be on the top of your list is the tax-saving fund or equity linked savings scheme (ELSS).

Apart from the unit-linked insurance plans, tax-saving funds are the only equity-linked investment to fall within the gamut of Section 88 investments.

In 1992, the government announced ELSS to encourage participation from middle-class investors in the equity market. Under this scheme, investments up to Rs 10,000 with a lock-in period of three years are entitled for tax rebate.

However, such funds are usually edged out by fixed-income schemes due to their inherent volatility and dwindling returns.

But the recent bull run in the equity market has brought such funds back into the limelight.

Let us see what works in favour of such funds.

Since investment in such funds is limited to Rs 10,000 per annum, it may not save much in tax, but they have the ability to generate huge returns and actually result in decent savings. For example, for the three-year ended February 23, the category posted an annualised return of 41.17 per cent.

Such funds can keep the taxman away and also give you the taste of equity investing. It also offers an opportunity to small investors, who may not be willing to expose a large sum of money to equity funds.

By design, the category has some advantages over other schemes. The first being the three-year lock-in period; in case of NSC and PPF, the minimum lock-in time is four and 15 years respectively.

Also, there is no lock-in period for dividends declared by such funds and being equity funds, the dividend amount is totally tax-free.

On the other hand, the lock-in period gives fund managers the scope to take long-term bets on the market, which may not be possible in the regular diversified equity funds. Though this makes the category more volatile than the equity funds, it gives a chance to generate higher returns.

How does one select such funds?

Apart from the tax benefit as an add-on, these funds are on a par with regular diversified equity funds.

In other words, the same yardstick needs to be used to select a tax-saving fund as for any diversified equity fund. This means performance, investment style, expenses and other critical parameters come into play and tax benefit takes a back seat.

The fund must also have a solid performance vis-?-vis the benchmark index as also its peer group. And since tax-saving funds have a three-year lock-in, this performance must stand out over longer time frames such as three years and five years. Equally important is the investment style and approach of the fund manager.

Great returns in isolation do not mean much, the volatility needs to be considered too. Admittedly, equity funds cannot really eliminate turbulence in their performance given their very nature. But it can be kept under control by a disciplined investment approach. Thus, one needs to identify funds with a lower volatility in NAV performance. Again, the expense ratio of a fund is an extremely important parameter since a lower ratio has a positive impact on the returns.