Consider the illiquid nature of closed-ended funds before investing

Updated: Sep 2 2014, 07:44am hrs
Does it make sense to invest in closed-ended equity funds for a duration of three years Are the current valuations attractive enough And do I have to pay any tax on the dividends

Alok Shah

Closed-ended schemes give the fund manager the confidence to invest, without the fear of redemptions in between. As a result, he can take a long-term call on companies he likes. Investors should, however, note that their money gets blocked for the tenure of the fund, and they should be comfortable with the illiquid nature of the investment. Also, some basic due diligence the fund manager, his track record, the AMCs culture of managing money and the manner in which the scheme is going to invest is important while deciding to invest in such schemes. In terms of valuations, the markets are currently trading at 16-17X forward earnings, which is marginally above the average that India has historically traded at.

Is it a good time to invest in gilt funds there are indications interest rates may fall as inflation cools off and with the new government wanting to fast-track growth

Deepak Mittal

The RBI, in its latest credit policy, has mentioned upside risk to inflation as one of key things it would be looking at before taking any decision to reduce interest rates. Also, other factors like the governments ability to control the fiscal deficit, the US Feds decision to raise rates or any flare-up in oil prices could also result in a change in the view on interest rates.

Also, the longer maturities in gilt funds tend to make them volatile compared to bond funds. The investor needs to be prepared for any interim volatility before making the decision to invest.

Are liquid funds akin to keeping money in a savings bank account What are the pros and cons of investing in liquid funds Do I have to pay tax on the interest earned

Shyam Gupta

While the returns from a savings bank account are known to the investor, those from liquid funds can vary depending on the prevailing short-term rates and the liquidity scenario. However, liquid funds have normally given returns higher than savings bank accounts. The dividends declared by liquid funds are subject to dividend distribution tax of 25% and other surcharges.

There are some arbitrage funds in the market. What are their tax benefits Where do they invest

Ashutosh Kumar

Arbitrage funds buy stocks of companies on the cash market and sell an equivalent amount of futures. The premium at which the futures trade compared to the cash market price is the return. Since these funds typically maintain over 65% exposure to such positions in the equity market, they are treated as equity funds from an income tax standpoint, which means there is no dividend distribution tax and long-term capital gains (over a year) are tax-free.

What are credit opportunity funds What is the risk-reward involved

Vikas Khemka

Credit opportunity funds generally have a higher allocation to bonds rated lower than AAA. Hence, such funds have YTMs 1-1.5% higher than normal bond funds. However, as an investor, you need to be comfortable with the kind of bonds these funds are investing into.

If the fund is investing in very high-risk instruments for getting the extra yield, there is a risk of losing capital in case of a default.

Second, these bonds are normally illiquid in nature and hence redemption pressure funds could result in distress selling of these bonds, resulting in losses for the investor.

Third, the investor should also look at the expense ratios of these funds. If the funds are charging expenses 50-75bps higher than normal bond funds, the additional returns may not commensurate with the risks that he is taking.

Do I have to pay any tax at the time of redeeming an ELSS does it make sense to invest in PPF instead it is tax-free at all stages and the returns are guaranteed and compounded

Aman Kumar

As an ELSS invests in equities, there is no need to pay any tax at the time of redemption. PPF is something you should definitely consider if you are comfortable with locking your money, given the I-T advantages it offers. Whether PPF should be considered over ELSS would depend on your risk profile and your asset allocation, for which you should consult a qualified investment advisor.

The writer is director manager research, Morningstar India

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