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In general, how does ELSS mutual funds generate higher returns over long term (say 5 years or so) when compared to flexi cap mutual funds? As far I know, in general both the segment of mutual fund have their major share in large cap, and small portion in mid cap and very small portion in small cap. I have heard that the lock-in period of 3 years in ELSS mutual fund helps fund managers to generate better returns. Can anyone explain the logic of how a lock-in period of mutual fund helps fund manager to generate better returns?

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  • 3 years of lock-in period may be as it releases the pressure of redeem considerably from MF Manager. Also, you may consider adding country tag India.
    – Aastik
    Commented Feb 7, 2022 at 13:28
  • @Aastik - Could you please explain more clearly on what is redeem pressure and how is it associated with MF returns? And I have added the India tag to the question.
    – Darshan L
    Commented Feb 9, 2022 at 17:03

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I am not expert on this topic, but as said in comment above, the core of the reason might be lock in period (as you correctly said in question) which helps MF managers to handle redemption pressure more efficiently.

Assuming that MF manager is following buy-and-hold strategy (which makes more sense in Flexi cap and ELSS), they should be hold the asset for as long as they planned to hold it. This is in theory though; this practically does not happen.
When there is sudden fall in market, weak investors will put a redemption request due to fear. This forces the MF manager to sell the stocks at bad prices. This causes NAV to go down.

With ELSS, there is lock in period of 3 years. Also, generally the investor who invest in ELSS is investing with the mentality of even longer tern. This provides a safe ground to MF manager to buy-and-hold the stocks they choose. As holding period is as per choice of MF manager now, naturally, it helps generating better returns.

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