Open-ended or closed, exiting hurts

MUMBAI: “Breaking up is never easy. But relationships you know are like mutual funds, you can choose to opt out, anytime you want to, but there is a certain cost involved, whether emotional or financial,” said Kavi Kumar, trying to start his class on a funny note.

As soon as he finished saying this, the backbencher woke up. “Kavi, I do not agree with you. What you say may work in case of an open-ended mutual fund, wherein one can choose to opt out at any point of time but not in case of closed-ended ones, wherein the asset management company (AMC) running the fund buys back the units from the investors only at certain specific intervals. This interval is usually of six months.”

Kumar certainly had not thought about this. “Well, you’ll agree with me on the cost part of it. Most of the time, an investor chooses to exit a fund, he has to pay a certain percentage of the net asset value (NAV) as exit load. If the NAV of the scheme is Rs 15 and the fund charges an exit load of 1%, the investor will get only Rs 14.85 per unit. {(1 –  exit load%) X NAV = (1 – 0.01) X Rs 15 = Rs 14.85)},” retorted Kumar.

“A closed-ended fund remains closed for a certain period. New investors cannot enter the scheme, but existing investors can exit on certain dates. But, generally, the exit loads tend to be higher vis-a-vis the exit load of an open-ended fund. Let’s take the case of a recent closed-ended fund, Standard Chartered Enterprise Equity Fund,”  he said.

“The fund will remain closed-ended for a period of three years. It has certain stipulated dates of repurchase, i.e. days on which it will buyback units from its investors at the repurchase price for the day. If the investor chooses to exit on December 31, 2006 or June 30, 2007, he pays an exit load of 3%, i.e, the investor will only get 97% of the NAV prevailing on that day. Moreover, if the investor chooses to exit on December 31, 2007 or June 30, 2008, the exit load will be 2%. This exit load reduces to 1% if the investor chooses to exit on December 31, 2008. So, over a period of time, the exit load of a closed-ended fund comes down. But there are exceptions to this rule. Like the recently launched Tata Equity Management Fund, which does not have an exit load at all. But, as we shall see, this does not mean that the investor does not bear any cost. Further, the scheme has a weekly exit option as well, making it more comparable to relationships that prevail these days, if I may say so.” continued Kumar.

“Other than the exit load, the investor also needs to pay up the unamortised initial issue expenses while exiting the closed-ended fund before the closed-ended period of the fund gets over. A closed-ended fund is allowed to incur initial issue expenses of up to 6% of the amount they collect during their new fund offer period. This helps the AMC meet expenses like brokerage and agent commission, and other expenses like marketing, advertising, printing, registrar expenses, bank charges etc. What this means is that for every Rs 10, a scheme raises through an NFO it is allowed to charge up to 60 paisa as initial issue expenses,” he said.  

“This 60 paisa is not charged up front and is amortised over the period the scheme remains closed. So, if the scheme remains closed for five years (i.e. 1826 days), this amount can be amortised over this period on a daily basis. Now lets say if the investor chooses to leave the scheme at the end of two years ( i.e. 730 days), he has only paid 24 paisa per unit ( (730/1826) x 0.6) of the initial issue expenses incurred by the AMC. So, while exiting, other than the exit load, the investor also needs to pay the balance initial issue expenses of 36 paisa per unit (0.6 – 0.24). Hence, if the NAV of the scheme at that point of time is Rs 25 and the scheme charges an exit load of 2%, the  investor will get an amount of Rs 24.16 ( ( 1 – exit load%) x NAV - unmaortised issue expenses = (0.98 x 25 – 0.36), making it even more painful, like breaking up,” said Kumar, trying to have the last word.