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Expecting superior returns from closed ended funds?
Published On , 4 Dec 2017 By TOI
In general, people refer to open ended funds when they speak about mutual funds. However, there's another type of fund, called closed ended fund, which is a lot different from an open ended fund.
A close-ended fund sells its units to investors only once, when they launch an offer, that is during the new fund offer (NFO). After that these units are listed on the stock exchanges and could be traded just like stocks are traded. In comparison, within an open ended fund structure the fund house is allowed to sell an unlimited number of units to investors. Investors, on the other hand, can sell their units back to the fund house if they need to redeem their investments. In case of open ended funds, the units are not traded on the exchanges but bought and sold by the fund houses themselves.
Within the closed ended structure, fund managers often settle for a concentrated portfolio where the portfolio usually holds 20-25 stocks and also the top 5-10 stocks usually make up for about 45-55% of the total portfolio. This approached is markedly different from a diversified portfolio strategy where the fund manager would typically hold about 40-50 stocks and no stock would contribute more than 10% of the total portfolio.
Usually concentrated portfolio strategy has stocks on which the fund manager has strong belief about outperformance, fund industry officials say. And a concentrated portfolio within a closed ended structure indicates that the fund manager expects the stocks in his/her portfolio to outperform his/her peers within the timeframe for which the fund is run. Most closed ended funds are launched for a three year period.
Unlike in a diversified portfolio where to reduce the total risks in the portfolio the fund manager would keep some stocks which constitute a small percentage of the total holding. Such a strategy is usually avoided in a closed ended structure. Under the current Sebi rules, however, usually no fund can invest more than 10% of its portfolio in a single stock.
There is another fund management strategy that also qualify for concentrated portfolio: In case the fund manager buys a large number of stocks from a select few industries and the weight of those industries in the portfolio is very high compared to all other industries.
Fund industry people believe that a concentrated portfolio strategy works well within a closed ended structure. In this case the fund manager buys some of the high-conviction stocks that he/she believes could give high returns over the duration of the fund. Since within this kind of fund structure the fund manager does not need to sell part of his/her portfolio, such concentrated portfolio of high conviction stocks could give returns superior to what could be achieved from a diversified portfolio. However, fund industry people warn that a concentrated portfolio strategy comes with some extra amount of risks as well. On the other hand, a diversified portfolio is built on the principles of risk mitigation.
Fund industry veterans also say that although the units of closed ended funds are listed on the bourses, there is very low liquidity. Hence if an investor is looking to invest in these funds, it is better to invest that fund which the investor may not require during the duration of the fund.
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