Recent launches show closed-ended funds to be very open

MUMBAI: Closed-ended funds may be making a comeback, but a scrutiny of recent fund launches, and the ones in the pipeline, shows that some are more closed-ended than the others. In the initial rash, three closed-ended funds were launched with five-year tenures between December, 2005, and February, 2006, garnering around Rs 3,200 crore among them. But the more recent closed-ended funds are choosing to go open-ended more quickly, making them more hybrid in nature.

The Tata Equity Management Fund, which plans to stay closed-ended for only 18 months, offers repurchases every week, does not have an exit load during the period, but ny investor seeking to leave early will bear the unamortised issue expenses. For all practical purposes, a weekly exit option is equivalent to an open-ended fund since the investor can exit at a time of his choosing. Only the cost of exit is higher, going upto 6% in Tata’s case. The still to be launched ING Vysya C.U.B Fund has a daily exit option.

Fund observers feel that the more recently launched closed-ended schemes are a direct response to Sebi’s order of April 4, 2006, which allowed mutual funds to amortise NFO expenses over five years only if they are closed-ended.

The Standard Chartered Enterprise Equity Fund (SCEEF) closed around 10 days ago while the Tata Equity Management Fund is still open. As per the original offer document filed by the latter with Sebi on March 21, 2006, the fund was supposed to be an open-ended equity scheme. What made the fund change its structure to a closed-ended fund?

Officials say investors are now more open to investing in closed-ended funds. “After a survey, we found that investors are more willing to look at long-term products. There is enough appetite for a closed-ended scheme and, ultimately, we would like to sell a product for which there is demand,” says Ved Prakash Chaturvedi, head of Tata Mutual Fund.

As per the new guidelines, open-ended equity schemes will have to meet the sales, marketing and other expenses connected with the selling and distribution of schemes from the entry load - or the de facto fees that they charge from investors entering the scheme. The entry loads for most open-ended equity schemes tend to be around 2.25%, though funds can charge loads of up to 7% of the amount invested. The scope of raising entry loads from 2.25% is very low as it has become an industry benchmark. If raised, the chances are that the scheme will not attract enough buyers. But closed-ended schemes can continue to amortise their initial issue expenses of up to 6% over the period the scheme remains closed-ended.

So if a fund launches a closed-ended scheme, it can incur greater initial issue expenses and get investors to pay for it. This can also help the asset management company (AMC) pay hefty commissions to its distributors to push a scheme, which are known to be in the range of 3-5%. This itself would constitute a chunk of the AMC’s initial costs. Market sources point out that it typically takes three years for an open-ended diversified equity scheme to break even. With the new norms, open-ended diversified equity schemes could take even longer to break even. Given this, AMCs are rushing to launch closed-ended funds.

Further evidence on AMCs’ preference for closed-ended schemes comes from the fact that after April 4, 2006, offer documents for five new closed-ended diversified equity funds have been filed with Sebi.

These funds are JM Value Fund, UTI Wealth Builder Fund, ING Vysya Cub Fund, Principal PNB Long Term Equity Fund and Tata Rural India Fund.

The normal logic offered by fund managers for launching closed-ended funds is simple: since the funds are locked in for a considerable period of time, it allows the fund manager to take a long term call on assets. In an open-ended fund, investors have the option to keep redeeming units as and when it suits them. If redemption pressures are high, fund managers have to keep selling valuable assets, possibly at a loss, which affects the interests of investors who choose to remain invested. 

But the old line separating closed- from open-ended funds is blurring, with NFOs shortening the period for which they are closed-ended. Fund observers say that the reduced tenure of closed-end period could attract more investors since the lock-in is shorter.