Personal Finance

Put close-ended funds under the lens

K Venkatasubramanian | Updated on February 16, 2014

bl17lens.jpg

bl17meter.jpg

Given their shortcomings and no distinct benefit, close-ended funds aren’t the best choice for investors

As fund houses launch a spate of close-ended equity schemes — reminiscent of the 1990s when this was the norm — it is important that you, as investor, assess carefully whether these schemes are for you. Fund houses sing praises of close-ended schemes citing a host of reasons, such as greater flexibility to the fund manager, freedom from sudden investor pull-outs and allowing depressed themes or sectors adequate time to bounce back.

But for investors, these funds may not be the best choice, given their many shortcomings. Apart from shackling investment freedom, close-ended funds do not offer any strategic benefits over open-ended funds in terms of investment mandate. Here’s a closer look at these aspects so that you make an informed choice.

Many drawbacks

The Morgan Stanley Growth Fund was launched in 1994 as a 15-year close-ended fund, amid much fanfare at that time. But the fund has been an underperformer compared with peer funds.

From its launch, it has delivered barely 12 per cent annual returns, against nearly 20 per cent managed by HDFC Equity over the same period.

Again, many infrastructure funds over the past several years that were close-ended have not been able to deliver as well.

Now, close-ended funds allow you to invest only during the NFO period, the first shortcoming. Investment being open only during the launch period is not a great idea given that the fund would have no track record to go by.

This also means that you would have to commit a lumpsum, which is fraught with risks as it would expose the entire sum to market gyrations.

It would also require timing, which may not be easy. There is no option to invest periodically through the SIP route till the lock-in period is over. That’s the second problem with close-ended funds.

The third critical aspect pertains to the liquidity associated with buying and selling the units while the lock-in period is in place. In case the close-ended scheme underperforms for a prolonged period of time, say, one-two years in a row, you would not be able to sell the units as the fund would not buy them back.

There is an option, of course, to buy or sell through the exchanges as these units are listed. But past experience has been such that selling has to be at a very significant discount (5-10 per cent in many cases) to the current NAV of the fund. So, losses become more pronounced in case you wish to get out of an underperformer.

No clear benefits

Apart from not being able to deliver, if at all, any significant outperformance, there are no advantages that close-ended schemes enjoy over their open-ended counterparts.

Of course, it can be claimed that close-ended schemes do not ‘suffer’ from redemption pressures. So, the fund manager can take more long-term bets that can deliver better returns.

That’s because these funds don’t have to worry about investors selling based on short-term performance, or maintaining enough liquidity to meet requirements if investors do sell.

But this argument does not hold true. There is no specific example of any outperformance delivered by virtue of being close-ended.

It can also be argued that close-ended funds can take exposure to depressed sectors at low valuations hoping that they would churn out good returns.

But there are enough open-ended funds available that follow one or more themes such as value, momentum, contrarian, and growth. And they have a track record as well to go by.

This means that you would be in a better position to take an informed call based on risk appetite, time horizon and available surplus on such funds.

There is the possibility that close-ended funds take bets that they believe would work. But what if it turns out to be a case of catching a falling knife?

It would not allow you to exit or rebalance your portfolio based on fund performance and can jeopardise your long-term corpus building process.

Bottomline

Only if there are no open-end funds with a similar mandate should you possibly consider such schemes.

This is apart from, of course, checking on the quality of the fund manager.

Published on February 16, 2014

Follow us on Telegram, Facebook, Twitter, Instagram, YouTube and Linkedin. You can also download our Android App or IOS App.

This article is closed for comments.
Please Email the Editor