Opening your portfolio to closed-ended funds

Written by Brijesh Damodaran | Updated: Aug 26 2014, 07:53am hrs
While the markets were on a roll, fund houses saw an opportunity in closed-ended equity funds, with a mandate to invest in mid caps and value stocks for 3-5 years. The mandate was required to ensure there is no flight of capital over the investing period determined by the fund manager.

Closed-ended equity funds are not new. An equity-linked savings scheme (ELSS) is also a

3-year closed-ended equity scheme that gives tax benefit under Section 80C of the I-T Act. The annualised returns generated by the top quartile of funds for the

3- and 5-year categories are over 18%. However, these funds are closely identified with tax-saving schemes by investors.

As an asset class, equity has delivered inflation-beating annualised returns over multiple holding periods, especially over five years. Data show that for investments made during periods of pessimism, or when fear is all around, the returns generated are usually greater than that

during a normal period.

The September-December period last year was one such time, where stocks were quoting at attractive levels and there were few takers for investment opportunities. This is where fund houses with conviction started offering equity schemes with the mandate to invest over a 3-year-plus period. The holding period is important based on past performance, returns generated are higher. This is where the concept of closed-ended funds gained traction.

Between November last year and March this year, over R2,300 crore was invested in these schemes. Another R120 crore was invested between April and July this year. So, what made investors put money in closed-ended funds when there were similar schemes in the open-ended category Some investors tend to divide their investments between safe and speculative investments.

Investment performance

How have closed-ended funds performed since their inception in November last year An absolute return of over 50%, with some of the funds having already declared dividends, distributing 10-25% of the initial investment as dividends back to the investor. These dividends are tax-free. All of this vindicates the investors stand. But in hindsight!

The proponents of the scheme had put forth the rationale of cheap valuation, lower price-to-earnings (P/E) and improving earnings per share (EPS) to take investors past the 3-year lock-in. At the same time, experts argued that when existing schemes of the said genre were available, what was the need for closed-

ended schemes

When you reflect and want to take an investment decision, there is no right or wrong in the opinions put forth. Its only about the nature and type of investment position in your portfolio. Closed-ended equity schemes could form a part of the satellite portfolio, delivering the alpha in your returns, with the beta driving investment performance.

With more such schemes being offered, what should you do The valuations of the last two quarters are vastly different. The earlier schemes had a head start, and catching up will be a big challenge for fund houses. If the fund manager sticks to the investment policy, returns will come. However, one should not compare returns from schemes with different holding periods. The allocation to closed-ended equity schemes should be based on your risk appetite and, most importantly, the time horizon of investment.

The author is managing partner, BellWether Advisors LLP