What happened to close-ended funds?

Circa 2006-07, close-ended funds were the season's flavour. Fund houses were busy convincing investors to get invested on the premise that close-ended funds furthered the cause of 'long-term' investing. Investors had a plethora of options to chose from since close-ended NFOs (new fund offers) of every conceivable kind were launched i.e. mid-cap, flexi-cap, thematic, fund of funds and tax-saving.

The genesis of close-ended funds
When equity markets hit a purple patch in 2003, fund houses capitalised on the same by launching equity fund NFOs. Most NFOs were of the open-ended variety. Fund houses were permitted to charge initial issue expenses (6% of corpus) to the fund and amortise the same over a period time. Initial issue expenses were largely used to meet marketing and distribution expenses. As a result, distributors were handsomely rewarded for their efforts in asset mobilisation.

A spanner in the works came in the form of a SEBI guideline that scrapped initial issue expenses on open-ended NFOs. Now, fund houses were required to meet NFO-related marketing and distribution expenses from the entry load; the norm was 2.25% of the sum invested. But close-ended NFOs were out of the purview of this ruling. While fund houses were permitted to charge initial issue expenses on close-ended NFOs, the trade-off was that they were prohibited from levying an entry load. The choice between initial issue expenses and entry load was a no-brainer. The result was a deluge of close-ended NFOs.

It would be unfair to paint all fund houses and close-ended NFOs with the same brush. Some close-ended NFOs did offer a truly innovative investment proposition. However, ignoring the marketing aspect would be naive.

The present scenario
It can be safely stated that close-ended funds are a forgotten breed now. Maybe, it had something to do with a subsequent guideline (January 2008), wherein SEBI decided that close-ended NFOs be treated on par with open-ended NFOs i.e. they would be permitted to charge an entry load and the provision to charge initial issue expenses was scrapped.

While close-ended funds may not feature on the priority lists of fund houses, it's a different scenario for investors. Several investors got invested in close-ended NFOs and continue to hold the same in their portfolios. Also, since then, markets have had quite a journey - an ascent to record highs, followed by a sharp downturn, and a recovery of sorts. It would be interesting to study how close-ended funds have fared so far.

The performance
Of the several close-ended funds launched in the 2006-08 period, 4 have a 3-Yr track record now. The following table shows how they have fared vis-à-vis comparable open-ended offerings from the same fund house and their respective benchmark indices.

	3-Yr (%)
Franklin India Prima	8.2
Franklin India Smaller Companies ©	6.6
CNX Midcap	16.8
HDFC Premier Multi-Cap	14.1
HDFC Long-term Equity ©	9.1
S&P CNX Nifty	15.2
ICICI Prudential Dynamic	18.2
ICICI Prudential Fusion ©	6.5
CNX Nifty Junior	18.7
Tata Tax Saving	12.6
Tata Tax Advantage 1 ©	14.3
BSE Sensex	14.6

(NAV and index data as on July 24, 2009. © indicates close-ended fund. NAV data sourced from www.amfiindia.com. Index data sourced from www.bseindia.com and www.nseindia.com. All data in CAGR terms)

As can be seen in the table above, close-ended funds have failed to match their benchmark indices over the 3-Yr period. Furthermore, with the exception of one fund, others have failed to match comparable open-ended funds from the same fund house. Even a cursory glance at performance of other close-ended funds (ones that have been in existence for less than 3-Yrs) will reveal that largely their performance is nothing to write home about.

It ain't over, till it's over
Critics might argue that the aforementioned funds need not be a representative sample of the entire close-ended funds category. Fair enough. But few would dispute that close-ended funds have failed to impress so far.

Fund houses are likely to justify the mediocre showing posted by close-ended funds on the grounds that these are early days. Given that most close-ended funds have a 5-Yr tenure, passing any judgement at this stage would be premature. Also, several funds have a provision for conversion into open-ended funds on maturity. Hence, should they fail to deliver in their close-ended avtaar, investors can continue to stay invested and exit the same at a more opportune time. While there might be some merit in the former argument (early days for funds), the latter certainly doesn't hold good.

Here's why - investments in close-ended funds were made on the premise that they would enable fund managers to make long-term investment decisions i.e. fund managers would not be weighed down by factors like redemption pressure and short-term market occurrences, that typically plague open-ended funds. When investors agreed to forsake liquidity (make a 5-Yr commitment) and bear initial issue expenses, the trade-off should have been a superlative performance. The least investors would expect is for close-ended funds to deliver a better showing than open-ended funds. And should close-ended funds fail to deliver, investors have every right to feel aggrieved.

What investors must do
Investors would do well to appreciate that not every promising proposition translates into a sound investment avenue. On paper, a close-ended fund with a defined maturity horizon and corpus sounds like an interesting idea; however, with the benefit of hindsight, it can be safely concluded that not every close-ended fund will live up to the promise. This underscores the importance of seeking diversification and a track record while making investment decisions.

Also, investors must keep track of their close-ended fund investments. Be patient and give them adequate time to prove themselves. Despite this, if they fail to deliver, don't hesitate to exit them after taking into account factors like the exit load. Perhaps an alternative fund with a similar investment proposition might be a better bet.

Investment tips from 'The Godfather'

For film buffs and critics alike, The Godfather pretty much embodies what celluloid magic is all about. Even 37 years after its release, the movie continues to capture the collective imagination of audiences across the world. Its characters, lines and performances are a part of folklore. Debates and discussions on what makes the movie tick continue till date. The film's enduring appeal to generation after generation only reaffirms its status as a true classic.

But there's a lesser-known aspect to The Godfather. Apart from being a source of inspiration to aspiring actors and filmmakers, the film has a lot to offer to investors as well. Following are 3 investment tips from The Godfather:

1. "Where does it say that you can't kill a cop?"

When the Corleone family is under attack, Michael Corleone (Al Pacino) comes up with a seemingly outlandish plan to eliminate his family's enemies. And that includes killing a corrupt police officer. Despite being scoffed at by his associates, Michael rationalises his plan by suggesting that they feed the media with stories of the police officer's corrupt practices and his links with the mob, and thereby defame him. Essentially, Michael shows the willingness to think out-of-the-box and take risk, without being irrational.

Likewise, the willingness to be unconventional and take on risk is vital for successful investing. Often, investors are guilty of sticking to certain avenues simply because they have always done so. For example, it is not uncommon to find investors who refuse to venture beyond bank fixed deposits and small savings schemes; the only explanation for their choice being, we have always invested in these avenues. By shutting the door on other options, investors might deprive themselves of the opportunity to meet their investment objectives. Of course, this should not be read as a recommendation to throw caution to the winds and invest in every untested investment avenue on offer.

All investors need to do is, be open to the idea of investing in avenues that offer a suitable investment proposition and be willing to take on acceptable levels of risk. For instance, a 25-Yr old investor who is saving for his retirement 35 years hence, can't hold a portfolio comprised of only fixed deposits and bonds; despite the higher risk, equities and mutual funds must find place therein. Remember, risk isn't bad; investing without being aware of it or failing to properly assess it, is what gives rise to thorny situations.

2. "It's not personal. It's strictly business."

This recurring line from the film has been used to great effect on each occasion. Every character who quotes this legendary line tries to impress on others that a given act or plan of action should be seen as a business decision. In other words, it has nothing to do with his personal feelings. Hence, the need to view the act in a dispassionate manner. The 'not personal' rationale holds true for investments as well.

At times, investors have a tendency to get 'attached' to their investments. This is especially true of market-linked avenues like stocks and mutual funds that have had a successful run. The trouble starts when the avenue is no longer equipped to perform as it has in the past. Similarly, there can be a situation wherein an investor gets invested in an avenue that fails to deliver. In both the situations, investors might be tempted to hold on to the investment; while in the former, it's the 'attachment' at work, in the latter, it's to get even.

Such an approach to investing is certainly unwarranted. An investment is simply a means to achieve a goal i.e. the investment objective. If a thorough evaluation suggests that the investment is no longer equipped to play the part that it was supposed to, investors must salvage the situation by getting rid of the same at an opportune price and time.

3. "Tom Hagen is no longer consiglieri."

When Michael decides to expand the family's operations, he decides to make certain changes. The significant one being that his brother/long-time associate, Tom Hagen (Robert Duvall) is sacked from the consiglieri's (advisor) post. His explanation for this rather drastic move is quite simple - Tom is not a not a wartime consiglieri and that things could get rough. Simply put, Michael prefers someone adept at strong-arm tactics over his brother, since the situation demands it.

An investor should routinely evaluate his relationship with the investment advisor/financial planner. The onus to ensure that investments are made and managed in the best interests of the investor, lies with the advisor. In effect, the investment advisor's integrity and competence are consistently tested.

Let's consider the emerging scenario in the mutual fund industry. With entry loads being scrapped, investors will be required to individually compensate advisors for services rendered. There can be a situation wherein an investor believes that his advisor isn't able to justify the fees demanded or perhaps his service standards aren't up to the mark. Should such a situation arise, investors shouldn't hesitate to terminate their existing relationship. Investing is serious business and there should be no room for incompetence or a slack attitude on the advisor's part.

Finally, be wary when someone "makes you an offer, you can't refuse". In The Godfather, this phrase refers to a veiled threat; refusal leads to dire consequences. In the world of investments, one can draw a parallel to investment propositions that claim to offer a win-win proposition. For instance, an investment that purports to expose investors to low risk, yet promises to deliver high returns. Remember, if an investment proposition sounds too good to be true, there's more than a fair chance that it is.

HDFC Top 200: An underrated achiever

Did you know that even investments can be exciting? Typically, asset classes or investment avenues that have hit a purple patch make the grade as exciting ones. Especially, the ones that have gone from obscurity to prominence in a short time span. They are written about in the media and instantly recommended by investment advisors. For instance, a fund that has delivered a trail-blazing performance and is perched at the top of the rankings. Even providers of financial services enjoy their fifteen minutes of fame; say a fund house that holds the largest asset size in the industry. Don't get me wrong. There is nothing wrong with an asset class, an investment avenue or a financial service provider being lauded and discussed, because it has delivered. In fact, it's only to be expected.

The trouble starts when one reads too much into the 'exciting' bit and makes investment decisions based solely on the same. Also, since most of the fanfare can be attributed to a recent showing, it is difficult to distinguish a 'flash in the pan' from a 'sustainable' performance. And for serious investors, the latter is certainly a more important evaluation parameter.

Then there are funds which don't qualify as exciting ones. Make no mistake, that's not the same as being non-performers. On the contrary, these can be funds that go about playing their part to perfection, but in an understated manner. They often deliver with enviable levels of consistency. Their performance over longer time periods and across parameters can be impressive. Despite this, there is never a frenzy surrounding them. It is not uncommon for such funds to be labelled as 'boring'.

Sadly, most investors fail to realise that in the context of investing, boring can be good. This is because, boring translates into predictability. And predictability means fewer unpleasant surprises. If you are building an investment portfolio to achieve certain objectives, boring funds of the aforementioned variety should account for a lion's share of the portfolio. The fact that a fund isn't in the limelight or isn't perceived as exciting is no reflection on its prowess. A competent performer stays the same irrespective of the attention it garners. HDFC Top 200 Fund (HT2F) is one fund that falls in the category of underrated achievers.

Originally an offering from Zurich India Mutual Fund, the fund became a part of HDFC Mutual Fund subsequent to the former's takeover in 2003. A diversified equity fund, HT2F's investment proposition is quite simple. It largely invests in stocks of companies featuring in the BSE 200 index. An interesting aspect of the fund is that it combines the active and passive styles of investing. It holds around 60% of its portfolio in line with the BSE 200 index. The fund has also benefited from the presence of its fund manager, Prashant Jain (Executive Director & CIO-HDFC Mutual Fund). Incidentally, Prashant Jain was earlier associated with Zurich India Mutual Fund. The fund's long-standing association with the fund manager has served it well.

Now for the performance. For a fund that has been in existence for well over a decade (inception in 1996), HT2F's track record is impressive to say the least. As on July 14, 2009, over the 3-Yr and 5-Yr periods, it had delivered 17.5% CAGR and 31.2% CAGR respectively; the corresponding figures for BSE 200 were 9.9% CAGR and 21.8% CAGR. Over the last 12 months, the fund posted a growth of 22.3% vis-à-vis just 3.1% for its benchmark. HT2F's NAV rose by 21.6% CAGR over a 10-Yr period as compared to 13.8% for BSE 200. And that is no mean achievement!

Any analyst worth his salt will agree that a fund's mettle is truly tested during a downturn. In recent times, after peaking in January 2008, domestic stock markets went into a downward spiral that lasted until March 2009. Over this (approximately 14-Mth) period, between it highest and lowest points, the BSE 200 shed 64.9% on an absolute basis; HT2F scored over its benchmark by losing 54.8%. In effect, the fund has fared better than its benchmark in both the upturn and downturn. HT2F is no laggard when it comes to competing with peers. Its showing vis-à-vis comparable peers (funds that predominantly invest in the large cap segment) is equally noteworthy.

Despite this, there is no perceptible buzz around the fund. No one is raving about its performance. This is hard to explain. For some obscure reason, HT2F lacks the 'X' (read exciting) factor that is much needed to draw attention.

What investors must do
For one, it would help if you don't let the hype or 'lack of it' affect your investment decisions. Always remember, investing need not be exciting; conversely, as mentioned earlier, boring can be good. You must check with your investment advisor/financial planner if a competent and proven, yet seemingly humdrum fund fits in your scheme of things. And if it does, by all means get invested.

(NAV data sourced from www.hdfcfund.com; data for BSE 200 sourced from www.bseindia.com)

Union Budget 2009-10: More 'yeas' than 'nays'!

Stock markets have given the budget a thumbs down; on last count, the BSE Sensex had shed nearly 800 points and was southbound. Maybe it was something to do with the fiscal deficit forecast (6.8% of GDP) or possibly the markets expected far more concrete announcements in areas like disinvestment. Perhaps, the expectations of a 'big-bang' budget were too much to live up to. However, individual tax payers are likely to have a different view. In all fairness, the budget has enough to elicit a nod of approval from them.

Here are some of the major provisions:

1. Exemption limit for personal income tax hiked
Lower taxes are universally welcomed with cheers, and this move will be received equally warmly. The exemption limit for personal income tax has been hiked by Rs 10,000 i.e. from Rs 150,000 to Rs 160,000. For women tax payers, the new threshold limit is Rs 1,90,000 vis-à-vis the erstwhile limit of Rs 1,80,000. Senior citizens stand to benefit the most. With an increase of Rs 15,000, the exemption limit has risen from Rs 2,25,000 to Rs 2,40,000.

2. Surcharge on personal income tax abolished
The Finance Minister (FM) announced his intent to phase out surcharge on various direct taxes. To begin with, he has eliminated the 10% surcharge presently applicable on personal income tax. Another move that will help reduce the tax outlay, much to the delight of assessees

3. Fringe Benefit Tax abolished
This one is meant for corporates and salaried individuals. Ever since its introduction in budget 2005-06, the Fringe Benefit Tax has been the subject of much debate and discussion. Industry captains have in unison debunked the same. With the tax being abolished, the FM has acknowledged popular sentiment.

4. Section 80DD deduction limit hiked
The deduction limit for Section 80DD, which covers expenses incurred for maintenance (including medical treatment), of a dependent who is a person with severe disability has been raised from Rs 75,000 (at present) to Rs 100,000.

5. Donations to electoral trusts
The FM also has something in store for the politically inclined. He has proposed that donations to electoral trusts be eligible for a 100% deduction in the donor's computation of income. For this purpose, electoral trusts will be trusts that are set up as pass-through vehicles for routing the donations to political parties, and are approved by CBDT.

The sleeper benefit
It was widely speculated that the small savings segment would undergo a rationalisation i.e. interest rates on popular avenues like the PPF and NSC would be reduced. None of that transpired. In fact, the small savings segment has been left untouched. In other words, investors can continue to enjoy assured returns coupled with attractive interest rates and tax sops. That is a big positive. Notwithstanding the softer interest rate regime, the small savings segment continues to be a haven for risk-averse investors.

The dampener
Some might argue that not much was done for investors in the New Pension System (NPS); the FM stated that the NPS would continue to be subject to the E-E-T method of taxation. Popular opinion suggested that NPS would be brought within the gamut of Section 80C; also, speculation was rife that the annuity/maturity sum received by investors would be made tax-free. However, one must appreciate that these are early days for the NPS. Also, tax benefits spelt out for the NPS trust should be seen as indicators of the importance being accorded to the scheme. Going forward, it shouldn't be surprising, if the NPS is subject to a far more benevolent taxation method. In any case, the FM did his bit for NPS by allowing self-employed individuals to participate in the scheme and avail tax benefits thereof.

As mentioned earlier, those who expected a 'big-bang' budget are likely to be disappointed. However, while evaluating the budget, it would only be fair to take into account the challenging economic environment and circumstances that we are faced with. Given the constraints, it can be safely stated that the budget has more 'yeas' than 'nays' for individuals.