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An open and shut case?

The right way is to invest regularly in a fund with a good record. In close-ended funds you invest at one go and only on hype.

Dhirendra Kumar | Print Edition: November 16, 2006

The Indian mutual fund industry has changed for the better in many ways over the past decade. One of the changes that every investor should have been very happy about is the death of closed-ended funds and the corresponding rise of open-ended funds. For those unfamiliar with the terminology, here’s the difference: a closed-ended fund has a fixed tenure. Investors can invest only at the launch and the fund will return their money only on maturity. Open-ended funds on the other hand give the freedom to invest whenever you want and redeem whenever you want.

Till about 1994, most Indian funds were closedended. After that, market forces made the industry shift almost completely to open-ended funds. Open-ended funds are better not just because they offer you the freedom to invest and redeem. This freedom also enables you to choose a fund with a proven track record and to get out if its performance declines. In contrast, closed-ended funds force you to buy solely on the basis of advertising hype because these funds can be bought only at launch when hype is all there is.

However, it seems that we have been rejoicing the demise of closed-ended funds too soon. The past few months have seen a strong revival in closedended funds. Between January 1999 and March 2006, there was only one closed-end equity fund launched. In sharp contrast, the past six months has seen 14 closed-ended launches. In fact, every new equity fund in the latest fiscal year has been closed-ended.

Why is this happening? In open-ended funds SEBI has now made it impossible for fund houses to hide the fact that it is investors who pay the marketing costs. However, the current rules make it possible for AMCs to still fudge expenses in closed-ended funds. Fund marketeers have realised that Indian investors are light-headed enough to buy almost any equity fund. The law says that fund houses have to pay to sell their open-ended funds. But investors can be burdened with the costs of sales campaigns of closed-ended funds. Therefore, the rush to launch these funds. Fund houses that have been launching only openended funds (and have actually converted closed-ended funds to open-ended) have started claiming that closedended funds are better for long-term investments. Of course, this realisation has occurred just when the expense accounting rules changed. What a coincidence! Should you buy closed-ended funds? Absolutely not. No matter what your opinion of the fund or AMC is, do not buy a closed-ended fund. The right way to invest is to choose a fund with a good track record and invest regularly. Closed-ended funds eliminate both possibilities; you have to invest all at one go and you have to invest only on hype.

There are more problems. Today’s closedended funds are actually not closed-ended but really “closed-start” funds. All offer some sort of exit window. People will rush to redeem when the market drops. But when the markets rise, these funds can’t raise fresh investments.

Fund companies claim that closed-ended funds have stable, long-term investors but that’s not true. Funds can only flow out but can’t come in. There are plenty of well-run open-ended funds to prove that a good fund manager can perform without the long-term perspective that closed-ended funds supposedly provide. I think that the sudden shift to closed-ended funds is nothing less than a scandal and it gives investors a raw deal. It’s time the regulator looked at this issue with the seriousness it deserves.

By Dhirendra Kumar, CEO, Value Research

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