Understanding Close Ended Mutual Funds

Understanding Close Ended Mutual Funds

 Summary: From last two years, “Post Demonetisation” there is a paradigm shift in investor’s behavior from Physical assets to financial assets, most of the investors increased their allocation in Equities & Mutual Funds. This change of mindset helped the mutual fund industry to touch its all-time high Asset under the management of 24 Lack crores. To grab this opportunity lot of Mutual Fund companies are coming with NFO’s (New Fund Offers), out of these NFO’s (New Fund Offers) there is a category of funds called “Closed-Ended Funds”. Today we are going to discuss in detail about these closed-ended funds.

First, let’s understand what is Closed Ended Funds?

Closed Ended Fund comes with Fixed Tenure (for example 3 years, 5 years, 7 years.. depends on each fund). Investors can invest in only new fund offer period time and they have to wait till maturity of the fund to get their money back.

Types of Closed Ended Funds: There are different types of closed-ended funds available in the market. Let’s get into details of most popular ones.

  1. Equity-oriented closed-ended funds

  2. Capital Protection/ Dual Advantage Funds

  3. Fixed Maturity Plans

Equity Oriented Closed Ended Funds:

In this category, entire money will be invested in Equities and these funds come with different names & themes like (Microcap Series, Value Fund Series, Emerging Equity Series, and Resurgent India Series.. So on). As Mutual fund companies know that once invested investors have to wait till maturity, Most of the funds in this category comes with aggressive or concentrated portfolios.

Advantage: As most of the fund's portfolios are Aggressive/Concentrated these funds may be delivered superior returns when compared with other funds

Disadvantage: Because of the concentrated portfolios the Risk in these funds are also much higher. One more disadvantage in this category is if the market corrects investors will not have the option to reinvest because of this they cannot average their NAV.

Suitable for: These funds are suitable for investors who can bare the highest amount of Risk and not require liquidity till maturity of the fund.

Not Suitable for: Investors who are Retired/ about to get retired and people who need liquidity.

Capital Protection/ Dual Advantage Funds:

In this category of funds, 80% of the portfolio is invested in debt securities and on remaining 20% of fund managers will take aggressive calls by investing in either Equity stocks or options.

Let’s see how these funds work:

If client invests 100 rupees in a 3-year maturity fund, out of which 80 Rs is invested in debt securities and 20 Rs is invested in Equity stocks/Options. If debt part of the portfolio gives an average return of around 8%,80 Rs invested in debt securities will become 100 Rs by maturity. The return gets generated from remaining 20 Rs which is invested in Equity is gain for the client, in a scenario if equity market doesn’t generate any return in that period client will get approximately 120 Rs against 100 Rs invested. In another scenario, if equity investment of the portfolio becomes Zero, still client can get back his capital of 100 Rs back because of debt part of the portfolio return.

Advantage: This category of funds has the potential to beat inflation because of 20% equity allocation in the portfolio.

Disadvantage: Liquidity is the major concern in this category, even though these funds are traded in stock exchanges there are hardly any buyers because of that investor has to wait till maturity of the fund.

Suitable For: This category of funds suitable for investors who want to take advantage of equity, however, they want their capital to be protected.

Not Suitable for: Investors who are Retired/ about to get retired and people who need liquidity.

Fixed Maturity Plans (FMP’s):

FMP’s are more popular among Institutional investors/ HNI’s ( High net worth investors) because of its tax advantage over Fixed Deposits, In this category of funds, 100% of the money is invested in Debt Securities Like (CD’s, CP’s). FMP’s are considered as an alternative investment to Fixed Deposits. Fund managers will not trade with investment securities in FMP’s because of that yields are constant.

Advantage: Taxation is the major advantage in FMP’s.

Let’s see how FMP’s score better than Fd’s in Taxation:

FD Investment Scenario: If Client invests 10 lacks in a 3 year FD which gives 10% yearly compounding interest. He gets 13.31 lacks towards maturity if he falls in 30% Tax bracket he has to pay 99,300 Rs as Tax. Post Tax his maturity amount will become 12,31,700 Rs which is the post-tax yield of 7.19%.

FMP Investment Scenario: If Client invests 10 lacks in a 3-year FMP which gives 10% yearly compounding interest, he gets 13.31 lacks towards maturity. As this FMP comes under “Long-Term Capital Gain Taxation” we need to consider indexation in those 3 years. If average indexation in those 3 years is 6%, the indexed amount will be 11,91,016, over and above-indexed amount client gets a gain of 1,39,984 this amount will be taxed at 20%, so tax on investment will be 27,996. Post Tax his maturity amount will be 13,03,003 Rs which is a post-tax yield of 9.22%.

Just with taxation advantage itself, the client gets 71,303 Rs as addition gain which is 2.03% additional yield over Fixed Deposit.

SAI KRISHNA PATHRI

CFP

( Mr Sai Krishna Pathri. is the Certified Financial Planner of Money Purse Advisory Services Pvt Ltd.) 

 



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