The Hindu Business Line : Fund Talk

I've invested in a couple of recently launched closed ended funds such as Franklin Smaller Companies Fund and Prudential ICICI Fusion Fund and find that the returns are not very impressive. I'm contemplating investment in some of the recently launched closed end funds. Would it be wise to do so? Could you throw some light on the investment strategy to be employed while investing in closed ended funds, especially where a plethora of such funds are tapping the market?

Amit Rao

We believe that an investor should consider a closed-end fund only if it offers a unique investment proposition not offered by any of the open-end funds in the market. Given the difficulty in predicting how a fund (especially an equity-oriented one) will perform at the time of launch, it is always in the investor's interest to retain the right to exit, if the fund fails to deliver on its promises.

The flexibility to exit an investment at a time of your choice is also crucial from a portfolio perspective. This is especially important under current market conditions, where we believe five years of significant gains in stocks have created a very challenging environment for equity fund managers, making it more difficult for them to deliver outsized returns.

This is not to say that investors should track the performance of their equity funds on a weekly or monthly basis and decide to exit, based on short-term performance. Remaining invested in an equity fund for at least a three or five-year term is necessary if you want to reap the benefits of stock market investing. However, you need not necessarily opt for a closed-end fund to reap these rewards; all you need is the discipline to stay with your open-end fund.

Theoretically, a closed end structure does make for easier fund management. By putting a stop to frequent outflows and inflows, closed funds allow the fund manager to take long term stock calls without the distractions of a volatile corpus. But on the flip side, closed-end funds also tend to load the dice in favour of the fund house. With investors locked in for the full term, there may be little pressure to perform. Moreover, there is little evidence in the Indian context that fund managers have actually used the closed end structure to deliver better returns to their investors. Closed-end funds, even those in existence for several years, have not delivered a superior performance relative to open-end funds with a similar investment mandate.

Therefore, we suggest that you check out the investment objectives of a closed-end fund and opt for it, only if you can find no other open-end fund already offering a similar portfolio. You could also invest in a closed end fund if you feel that the structure is justified because of the investment objectives of the fund. Fixed maturity plans offered by fund houses are a typical example of closed end funds that do offer material benefits to investors.

By matching the debt securities they buy to the term of the scheme, FMPs allow investors to lock into prevailing yields on debt instruments and earn a predictable return on their investment. In case you are considering an equity fund, invest in a closed-end offering only if you are absolutely certain about the credentials of the fund house offering it and know that the other funds managed by it have a good long term track record.

AARATI KRISHNAN

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