With the equity pendulum swinging wildly and steadily moving to lows, we thought we were left far behind. It?s not just alternate sources of income but alternate places to keep your money, to stay above inflation, that is essential. Unfortunately, in today?s scenario more than ever, risks and returns seem to be going hand-in-hand, as even the safest options like fixed deposits earn you negative real interest. However, an interesting option available to us, which is ?almost completely risk-free, are the recently launched debt interval funds? says Manish Tawade, senior management of mutual fund research, Religare.
On September 27, 2007 the Securities and Exchange Commission passed a rule establishing a new type of mutual fund that allows investors to cash out periodically without having to sell at less than the fund?s net asset value. These are ?interval funds?, which allow investors to sell their shares back to the fund at periodic time intervals as specified by the fund. This could be quarterly or half yearly.
How does this work?
The most common definition of an interval fund is a fund that combines the features of open-ended and closed-ended schemes, making the fund open for sale or redemption during pre-determined intervals. Essentially, this is a mutual fund with redemption features in between those of closed-end and open-end funds. The general working of an interval fund is the same as any other mutual fund in the market. However, as these funds are essentially debt funds; they tend to be relatively safer. ?Income and short-term income funds have a higher risk as they are often undefined. In the case of interval funds there is an indicated yield given. This yield is achieved most times as these funds take lesser risks,? explains Manish. With the equity markets being volatile, investors are leaning towards debt funds, FMPs, and interval funds.
Here, the returns are in the range of 9-10% and the overall scenario looks good. There has been a positive response towards interval funds explains Manish. ?All debt fund movements are closely related to interest rate movements. So, if the interest rate goes down, income funds and other debt funds would outperform interval funds. However, if the interest rates rise or remain steady then the reverse is true. Hence interval funds are doing well now,? says Manish, who feels that these funds are almost safe as a bank and are a much desired investment option amongst investors looking to safeguard their wealth against inflation.
In an interval fund, there are specific time frames during which you can redeem your shares to the company at the NAV at that time. This time interval could be monthly, quarterly, half-yearly or yearly and if an investor chooses to off load during this time, there is no exit load charged. Some interval funds allow you the flexibility of selling your units in-between these time frames as well.
However, this will have to be done in the secondary market and an exit load will be levied on this transaction. Interval funds often work in a series plan, and after each maturity period, a new series of the same fund is taken forward. If you do not wish to exercise this redemption option on the maturity date, your investment will automatically be carried forward in the other series of the fund. The indicative return on every roll over will be communicated and will vary. In short, on a specified date, in an interval fund, there is an automatic roll-over, while in a normal FMP there is redemption. Interval funds are hybrid mutual funds that represent a step between closed- and open-ended funds. These funds are more like closed-end funds because they have more control than open-end funds and yet provide investors with a sense of liquidity
?Interval funds are one such product from our portfolio of debt products. It is difficult to compare one product from an asset class with another product, as each product has a different mandate and is designed to cater to investors with various risk profile, investment objective and liquidity need. The key feature of an interval fund is that these funds offer a redemption option to the investors during pre-determined intervals at NAV related prices, which is a key advantage. These funds allow superior asset liability management as the cash flows are periodic and the maturity of the interval is usually matched with the tenor of securities in the portfolio. Also, the volatility will be lower, as a reasonable proportion of assets will mature in line with the respective interval plans. As the flow of cash is timed, the day-to-day monitoring requirement will be low, hereby reducing the costs. Considering the current scenario of market volatility, interval funds will play an important role in providing the investors investment portfolio the advantage of stability? explains Chaitanya Pandey, co head – fixed income, ICICI Prudential AMC.
Why do fund houses and managers prefer ?interval funds??
Interval funds came into the markets as a boon, given the current situation of things. This is as such a fund that benefits both the company that has launched the fund, as well as investors who have invested in it. These funds are even over-taking FMP?s (fixed maturity plans). This is primarily because as with an FMP you have to pay Sebi a filing fee every maturity date, when people enter and exit the fund. In comparison, in interval funds, you do not need to pay Sebi each time an investor goes in or out of the fund. This makes these funds an attractive proposition for companies who want to launch a fund. With internal funds, a fund manager has the advantage of managing the corpus without having to contend with fresh inflows and outflows at varied points in time, which may prove to be detrimental to the fund performance. Here the fund manager is more likely to tailor the maturity of the fund according to his own judgment, based on the pre-determined maturity dates, and hence can maximise returns in the short-run. Since in such cases the term to maturity of the fund is fixed at regular time intervals, an investor is subject to the interest rate risk. Thus, when the time comes for to the investments to be redeemed, the interest rate movements may lead to a decline in the value of the investment. However, if the fund manager actively manages the investment the returns could also be higher. All in all, since this fund offers flexibility, constant short-term planning, and are more interest rate linked, they allow the funds to optimise their performance.
What do you gain?
The advantage of interval funds is that it allows an investor more flexibility than the close-ended funds, for he can sell it at the predetermined time. Investors have liquidity of capital at regular intervals of time. Also, these funds are better run than opened funds, where a certain percentage of the fund?s money is always liquid, to cater to the constant inflow and outflow of investors.
?If you feel you are getting the best returns now at the current NAV on the maturity date, you should redeem it then. Though the major advantage investors have here is that, their money is locked up for limited periods of time, offering known liquidity and security. Keeping invested in interval funds till the equity markets revive is a good idea and it is better to invest in these now and take a call on roll-over or redemption at the maturity date, based on the equity market and interest rate scenario and trend? says Manish.
In an FMP, investors must redeem their investment at the end of the tenure, pay applicable taxes and reinvest in another FMP. But in a debt interval fund, they simply roll over their investment.
Debt-interval funds also help investors plan their cash flows as redemption and subscription periods are fixed. Also due to constant fluctuations in the interest rate, open-ended interval funds, are constantly monitored and managed accordingly. Another edge is the advantage of long-term capital gains if you have stayed invested for more than a year. Since the tax rate on long-term capital gains is lower, the post-tax returns are higher.
?Interval funds/FMP?s are an important asset class and will form an important part of an investor?s portfolio, as it provides the investors portfolio with stability specifically during volatile times. We expect similar products to be launched in the future based on investor appetite,? explains Chaitanya.
All in all, interval funds are another of what you call the hybrid funds that have been launched in the market. Currently, ICIC, ABN AMRO, Sundaram, Lotus, and UTI amongst others have already being running interval funds and more are joining this bandwagon. The key in investing in all hybrids is to see if the advantages detailed by the fund, are of a personal benefit to you or are just gimmicky in nature. While these funds seem to be good in most fronts, they have not yet been time-tested . How they fare in different market conditions and lower interest rate scenarios is yet to be seen. So while in the short run these funds are worth looking at, it might be a while before these funds carve a niche of their own.