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The January-February 2018 Issue

If you look at draft offer documents being filed by asset management companies with the Securities and Exchange Board of India, you will come to realize that an overwhelming portion of them relate to close-end structures. Clearly, these constitute a very critical part of the mutual fund industry’s new initiatives, aimed at shoring up their assets and reaching out to investors by routinely widening their product baskets.

What do allocations in close-end funds mean for investors? How can these funds add value to their overall portfolios? Today, as we address these issues, we will consider the major features that define the contemporary close-end scenario.

Close-end funds are true-to-label options: you can’t hop on them once they have mobilized their initial corpus, nor can you hop off them before maturity. Of course, their listed status gives you an opportunity to get out – provided there is enough liquidity, of course. In most cases, investors are expected to stay for the entire duration. Thus, its pre-determined time-frame serves as the cornerstone for a close-end fund.

Now, this acts as a boon of sorts for the fund manager, who does not need to worry too much about redemptions. In the classical close-end structure, unit holders who are willing to exit normally do not exert such pressure – the fund does not have to sell securities in order to avoid a possible redemption-related predicament.

What does this mean for investors?

Close-end options are for the serious investor, the one who knows that he will have to stay put till the day of redemption. In this context, I need to discuss a few points.

  • Typically, transaction costs can tend to be lower in the average close-end fund than in its open-end counterpart. Remember, here the fund manager need not sell or buy too frequently if he is convinced about the securities he has in mind.
  • Purchase can be made to coincide with planned expenses here. For instance, an expensive international trip to be undertaken, say, in December 2019, can be funded, at least partially, by an investment in a close-end fund that will mature at around the same time.
  • This brings us to a critical aspect – choice of funds. Which sort of funds should you select? Which factors should govern your picks? Well, the simple answer is that your choice should be determined by your risk-return analysis.

In other words, select close-end funds only when they match your profile. Naturally, I assume you will be comfortable with the restrictions they place on on-going redemption.

There are negatives too

So now that you know about choice, you will probably join the league of so many other smart investors – you will buy open-end funds for major allocations. But I do advise you to consider leaving some room for close-end structures as well.

Now, whether this should make up 15 per cent of your aggregate allocation or 25 per cent, is not for me to suggest. You and only you can take the right decision at this juncture.

Yet, an investor must remember the potential negatives. Since exit is not so easy here, what does he do when he has the urge to move out before the actual day of redemption? Apparently not much, not even when he has recorded gains or, better, not even when he has surpassed his profit-expectation. I am not even broaching the subject of emergency withdrawal, an aspect that I leave to the reader’s imagination.

Asset mix

The strategy adopted by a close-end fund in terms of its asset allocation is a big determinant from a lot of angles. For a five-year structure, for example, a fund manager can embrace a dynamic stance – less rigid than in the case of, say, an 18-month product.

An investor who can afford to stay locked-in for five years can benefit from exposure to equity in a big way. A fund with a shorter duration will probably make do with a predominantly fixed-income strategy. The latter may lead to predictable by comparatively weaker performance.

In the past, fund houses have unleashed a number of close-end products with various kinds of debt-equity mix. On a standalone basis, each asset class has unique advantages. Simultaneously, each has its own set of risks. Those who can live with these can consider investing in the days. Otherwise, simply stick to open-end products and enjoy your journey.

Close-end scene: Recent filings

Name of fund house Name of fund
Sundaram Value Fund, Series XI – XII
Aditya Birla Sun Life Fixed Term Plan, Series PA to PE
HDFC Fixed Maturity Plan, Series 39
IDFC Fixed Term Plan, Series 140 – 145
SBI Long Term Advantage Fund, Series V & VI

Source: SEBI

(Excerpts of this newsletter were published in The Telegraph in January, 2018)


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Disclaimer: All information provided in this newsletter is obtained independently from sources that are considered reliable and authentic. Wishlist Capital, its associates, stakeholders and partners, will not be liable in any way for inaccuracies or errors that may have been included inadvertently. Investment decisions, taken now or later on the basis of this newsletter, are entirely your own.