Is it worth investing in close-ended mutual fund schemes now?   Jan 13, 2014

In the recent times as many of you may have witnessed, mutual funds houses flooding the markets with New Fund Offers of close-ended funds; and you may have even received a call from your mutual fund distributor / agent / relationship manager asking you to invest into the same. So we at PersonalFN, thought of evaluating, whether such close-ended funds would be worth investing in current times.

At present the following mutual fund houses have floated closed-ended funds:
 

Let’s understand each of them in detail…

SBI Dual Advantage Fund – Series I (SDAF – Series I):

This is a five year close-ended hybrid mutual scheme from the stable of SBI Mutual Fund, which will focus on investing in predominant portion of its assets in debt and money market instruments and the balance in equity and equity related instruments (including derivatives). The key features of this fund are as under:
 

• Investment Objective
  
  The primary investment objective of the scheme is “to generate income by investing in a portfolio of fixed income securities maturing on or before the maturity of the scheme. The secondary objective is to generate capital appreciation by investing a portion of the scheme corpus in Equity and equity related instruments."
  
  However, there can be no assurance that the investment objective of the Scheme will be realized.
   
• Benchmark
  
  SDAF – Series I would follow CRISIL MIP Blended Index as its benchmark, as the composition of the said index is most suited for comparing performance of the scheme.
   
• Portfolio & Investment Strategy
  
  As mentioned earlier, a dominant portion of the fund’s assets would be invested in fixed income instruments (debt and money market). And while doing the same, it would invest in securities which will mature on or before the date of the maturity, with a view to hold them till the maturity. While taking a credit exposure to fixed instruments, SDAF-Series I would judge them on the basis of financial parameter such as:
   
  • Turnover;
  • Net worth;
  • Gearing;
  • Interest coverage ratio; and
  • Profitability track record
     

  Companies in the investment universe will be initially screened on the basis of management quality, business and Industry analysis & feedback from creditors/ rating agencies. And only those companies which meet these initial screen norms would be evaluated on the financial norms for consideration in the investment.
  
  Investments in sovereign papers would be based on interest rate expectations arising out of macroeconomic analysis, which includes analysis of:
   

  • Inflation data;
  • Trend in credit growth;
  • Growth in money supply;
  • Liquidity;
  • Fiscal numbers; and
  • Global interest environment
     

  For managing the equity portion, in which SDAF-Series I invests a diminutive portion, the fund will follow a mix of bottom-up & top-down approach to stock-picking and endeavours to maintain a diversified portfolio of equity and equity related instruments. The fund will primarily focus on companies that have demonstrated characteristics such as:
   

  • Market leadership;
  • Strong financials; and
  • Quality management
     
• How will the scheme allocate its assets?
  
  SDAF-Series I will allocate its assets under as under:
    For schemes with maturity greater than 12 months and less than or equal to 13 months:

  Instruments	Indicative Allocation Range (%)		Risk Profile
  	Minimum	Maximum	High/Medium/Low
  Debt and debt related instruments* & money market instruments	90	95	Low to Medium
  Equity and equity related instruments including derivatives#	5	10	High

    For schemes with maturity greater than 13 months and less than or equal to 24 months:

  Instruments	Indicative Allocation Range (%)		Risk Profile
  	Minimum	Maximum	High/Medium/Low
  Debt and debt related instruments*	45	95	Low to Medium
  Money market instruments	0	35	Low to Medium
  Equity and equity related instruments including derivatives#	5	10	High

    For schemes with maturity greater than 24 months and less than or equal to 36 months:

  Instruments	Indicative Allocation Range (%)		Risk Profile
  	Minimum	Maximum	High/Medium/Low
  Debt and debt related instruments*	50	95	Low to Medium
  Money market instruments	0	25	Low to Medium
  Equity and equity related instruments including derivatives#	5	25	High

    For schemes with maturity of more than 36 months:

  Instruments	Indicative Allocation Range (%)		Risk Profile
  	Minimum	Maximum	High/Medium/Low
  Debt and debt related instruments*	55	95	Low to Medium
  Money market instruments	0	10	Low to Medium
  Equity and equity related instruments including derivatives#	5	35	High

  *Exposure to domestic securitized debt may be to the extent of 40% of the net assets. #Exposure to derivatives may be to the extent of 30% of the net assets.
  (Source: Scheme Information Document)
  It is noteworthy that the proportion of each of the fund’s portfolio invested in each of the security will vary in accordance with economic conditions, interest rates, liquidity and other relevant considerations, including the risks associated with each investment.
  
  
   
• Who will manage the scheme?
  
  The debt portion of SDAF- Series I will be managed by Mr Rajeev Radhakrishnan, while the equity portion will be managed by Mr Richard D’souza.
  
  Mr Radhakrishnan has a total experienced of 10 years, of which 8 years has been in fixed income funds management and dealing. Prior to working with SBI Mutual Fund, he was associated with UTI Mutual Fund, as a fund manager. Mr Radhakrishnan has to his credit a Bachelor’s degree in engineering (B.E), a Master’s degree in management studies with specialization in finance [MMS (Finance)] and holds a CFA charter. At SBI Mutual Fund he also manages SBI Magnum Insta Cash Fund, SBI Premier Liquid Fund, SBI Magnum Children Benefit Plan, SBI Regular Savings Fund, SBI Capital Protection Oriented Fund – Series II & Series III, SBI Short Term Debt Fund, SBI Ultra Short Term Debt Fund and the existing SBI Debt Fund Series.
  
  Mr D’souza has work experience of 19 years in equities as a portfolio manager and as a Research Analyst on the sell side. He has been associated with SBI Mutual Fund from April 2010 onwards as Fund Manager for the Retail PMS division. Prior to joining SBI Mutual Fund, he has worked with ASK Investment Managers Pvt. Ltd. as a Portfolio Manager, with Antique Share & Stock Brokers Pvt. Ltd. (post-merger with Four Dimensions Securities Pvt. Ltd.), as Research Analyst (on the sell side) and also with Sunidhi Consultancy Ltd. and Alchemy Share & Stock Brokers Pvt. Ltd. Mr D’souza hold a Bachelor’s degree in Science from the University of Mumbai, with specialisation in physics [B.Sc. (Physics)]. At SBI Mutual Fund he also manages SBI Tax advantage Fund – Series I, II & III, SBI Magnum Multicap Fund andequity portion of SBI Capital Protection Oriented Fund – Series II & III.
   
• PersonalFN’s outlook onSDAF-Series I
  
  SDAF-Series I at most times is mandated to invest predominantly in debt and money market instruments to achieve its primary objective; and a small portion in equity and equity related instruments in order to achieve its secondary objective. While the fund holds the flexibility to invest across instruments on the debt side with a view to stay with such securities until maturity, the imminent risk is looming around for the Indian debt markets on account of the following amongst others:
   
  • Persistent inflationary pressures;
  • Run-up in the fiscal deficit data (which came in at 93.9% of the budgeted target of Rs 5.42 lakh crore in the first 8 months of the present fiscal year);
  • Slowdown in economic growth;
  • Lull in industrial activity; and
  • Chances of a sovereign rating downgrade
     

  Moreover, RBI has clarified previously that no single data point would decide the course of policy action and in its 3rd mid-quarter review of monetary policy 2013-14 has made it clear that it could act off-policy dates, if warranted (so that inflation expectations stabilise and environment conducive to sustainable growth takes hold). So in such times, construction of the portfolio would be a challenge as the interest rate scenario is yet not clearly known.
  
  While taking exposure to equities too, along with the aforementioned macroeconomic variables, the political landscape ahead of general elections in mid-April would set the tone for the markets. And at the elevated levels of the Indian equity markets, portfolio construction would be challenging task, which does not provide enough margin of safety and risk-return trade-off, especially it being pre-election time and U.S. Federal Reserve have decided to taper stimulus.
   

• So, is SDAF-Series I suitable for you?
  
  SDAF-Series I being a hybrid fund offers tactical allocation between debt and equity. But as cited in the outlook, the risk seems imminent and since there is nothing very unique in the offering it would not be worth taking the risk, especially when there are other funds such as Monthly Income Plans (MIPs) or dynamic bond funds which offer tactical allocation.
   

Sundaram Select Micro Cap Series II (SSMC-Series II):
This is a five year close-ended equity mutual scheme from the stable of Sundaram Mutual Fund, which will focus on investing predominantly in stocks in the micro cap domain. The key features of this fund are as under:

• Investment Objective
  
  The investment objective of the scheme is "to seek capital appreciation by investing predominantly in equity/equity-related instruments of companies that can be termed as micro-caps.
  
  A company whose market capitalisation is equal to or lower than that of the 301st stock by market cap on the NSE at the time of investment will be considered to be in micro-cap category."
   
• Benchmark
  
  SSMC-Series II would evaluate its performance against the S&P BSE Small-cap Index set as its benchmark.
   
• Portfolio & Investment Strategy
  
  SSMC-Series II while building its portfolio would endeavour to adopt a bottom-up approach to stock picking and shall pursue a strategy which tries to capture emerging stocks through its study of industry and management. As conferred in its name, SSMC-Series II would focus on investing in a diversified portfolio of micro cap stocks and since there is no fixed thumb rule as what constitutes to be a micro cap stock, the fund has fixed its universe using the threshold of stocks with a market cap equal to or lower than that of the 301st stock by market cap on the National Stock Exchange (NSE).
  
  While focusing on investing in micro caps, the fund will emphasise on investing in companies with:
   
  • Quality management;
  • Unique business strengths;
  • Sustainable long-term growth prospects; and
  • Reasonable valuations
     
  And as a part of the analysis, the fund will focus on the following amongst host of other aspects:
   
  • Past performance;
  • Future prospects of the company and its business;
  • Financial health;
  • Competitive edge;
  • Managerial quality & practices;
  • Minority shareholder's interests; and
  • Transparency
     
  In selecting particular companies for investment, the fund lays emphasis will on growth potential for the company as well as the sector to which the company belongs. Also, value investing would be done, if the equity markets and industrial activity necessitate such a decision as long as stocks in this category do not appear to be a value trap. So given that, the fund would follow a blend style of investing.
  
  As far as portfolio turnover is concerned, given the nature of the scheme and its market capitalisation bias of investing in micro cap companies, SSMC-Series II may see a high portfolio turnover, but the fund manager may be relieved from the pressure since it being a close-ended equity fund.
   
• How will the scheme allocate its assets?
  
  Under normal circumstances the asset allocation pattern of SSMC-Series-I will be as under:
   

  Instruments	Indicative Allocation Range (%)		Risk Profile
  	Minimum	Maximum	High/Medium/Low
  Equity and equity related securities of companies of micro-caps	65	100	High
  Other Equity	0	35	High
  Fixed Income and money market instruments	0	35	Low to Medium

  (Source: Scheme Information Document)
  Moreover, the fund may also use derivatives for such purposes as permitted by the regulations, including for the purpose of hedging, portfolio rebalancing and trading, based on the opportunities available and subject to the guidelines issued by SEBI from time to time.
   
• Who will manage the scheme?
  
  The fund's investments will be managed by Mr S. Krishnakumar who has over 15 years of total experience. Before joining Sundaram Mutual Fund as a fund manager in December 2003, Mr Krishnakumar was associated with Anush Shares & Securities for seven years (as a Vice President-Research) and before that with Lucas TVS for six years.
  
  He has to credit, and engineering degree from the Regional Engineering College (now National Institute of Technology), Trichy and is an MBA from Loyola Institute of Business Administration, Chennai. At Sundaram Mutual Fund he also manages Sundaram Select Midcap Fund and Sundaram S.M.I.L.E. Fund. He also co-manages Sundaram Capex Opportunities Fund, Sundaram Energy Opportunities Fund and Sundaram Equity Multiplier Fund.
   
• PersonalFN’s outlook on SSMC-Series II
  
  SSMC-Series II proclivity to the small cap index along would attract very high volatility and therefore command very high risk of investing. Also there are possibilities that the fund may encounter low volume and low liquidity in some stocks in the portfolio, even though it follows a bottom-up approach to stock picking and has enunciated the investment strategy it would follow. Thus the fortune of SSMC-Series II would be closely linked with the performance of the small cap index. Moreover as mentioned earlier, given the nature of the scheme and its market capitalisation bias of investing in small cap companies, SSMC-Series II would see a high portfolio turnover which may consequently result in higher brokerage and transaction costs.
   
• So, is SSMC- Series II suitable for you?
  
  It is noteworthy that Small cap stocks have a potential to generate super-normal returns. Smaller companies tend to grow faster than mid and large sized companies. But since they are placed at the lower end of market capitalisation, they are under-owned and as result of which, volumes and liquidity are generally low. Thus given this trait, SSMC-SeriesII is likely to be quite volatile and therefore would command very high risk. Therefore before investing one's hard earned money, it is imperative to take into account his / her risk appetite and risk tolerance.
   

Why are fund houses launching such funds now?

Well, mutual fund houses are banking on the positive mood prevailing in the Indian capital markets and perceive that they would get investors to subscribe to their products. Moreover, hit by redemption in other equity mutual fund schemes they are turning to close-ended mutual fund schemes for bringing stability to their Assets Under Management (AUM). Also they are of the view that it would facilitate better management of portfolios with the scheme being close-ended in nature.

But is it worth investing?

The fact is, most close-ended scheme launched in 2007 just before the financial crisis of 2008, which led to the markets slump; have not created wealth for investors. The launch of aforesaid mutual fund schemes – and probably many more in the offing - is again at a time when the Indian equity markets have touched an all-time high in the recent past; and even on the debt side, there are hopes that the central bank would reduce policy rates in the second half of this calendar year, once inflationary pressures recede. But during such times, construction of portfolio would be a challenging task; and more so when some macroeconomic variables such as economic growth, industrial activity, inflation and fiscal deficit remains a concern. Also there are global headwinds, with the U.S. Federal Reserve having decided to wind-down the current pace of its bond-buying programme by U.S. $10 billion. Thus while the broader markets have touched an all-time high, the margin of safety seems to have narrowed and thus it would not be worth taking the risk. Moreover, the investment proposition offered by the aforesaid mutual fund schemes isn’t anything unique to make it worthwhile. Hence, investors would be better-off avoid investing in such funds and instead prefer exiting mutual fund schemes having a consistent and appealing performance track record, and are from fund houses which follow strong investment processes and systems.

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