Don’t be closed minded about closed-end funds

By Morningstar |  17-04-18 | 

You would find this post strange considering that this very month we wrote a post titled Why closed-end funds are not such a sweet deal.

Kalpen Parekh, president at BlackRock Mutual Fund, has a perspective on the debate about closed-end funds being bad for investors.

His stance has been reproduced below.

With reference to this debate in the mutual fund industry, my views can be succinctly summed up to say, good funds are good and bad funds are bad. Let me elucidate.

There are many open-ended funds, of which some are good and some are bad. Likewise, there are many close-ended funds of which few are good and few are not. Rather than making a generic assumption that each and every close-ended fund is a bad fund, it is important to first tackle the issue of what specifically the intention of a close-ended fund is.

Ideologically, if one were to debate, then every Fixed Maturity Plan, or FMP, is a close-ended product in fixed income. The industry has seen growth in close-ended FMPs over the last few years, especially in rising rate regimes because they give comfort to investors about the finiteness of the product, likely yields at which assets are locked. As a result, this category has been popular in the past in spite of the fact that similarly managed open-ended debt funds have done as well, or at times, even better than some of these FMPs.

But simply by design, making it close ended enhances the demand of the product as it appeals to the behavioural expectations of the investor. Can we say that all FMPs are bad?

Before labelling all close-ended funds as good or bad, it is important to ask what is the intent, design objective and differentiation offered by the fund.

Close-ended funds could be thematic in nature; they can be unique and boast of niche strategies which we can’t run in full concentration in existing funds. It could be a strategy that has a finite life and hence the need to be timed. It could be a new idea meant for select investors who are willing to look at a different risk profile and invest accordingly.

For example, DSP BlackRock Mutual Fund recently wanted to innovate via two new concepts (Portfolio built only by Analysts – in Equal weights within sectors and a low-cost put option to reduce volatility) which we didn’t have in our open-ended schemes. Both would have not been implemented in any of our existing open-ended products in which pre-defined mandates are already fixed as per their respective offer documents. Hence, we offered this new concept via a 3 year, close-ended fund.

So without diluting those mandates for existing investors, a close-ended fund served the need for us to create a new design for a different set of investors and complement the existing range of products. This, in my opinion, is a classic example of how we can bring thematic innovation through close-ended funds.

Another feature in favour of close-ended funds is that it keeps a check on rash investor behaviour. Many times, when the market turns volatile, just because open-ended funds have the liquidity option, investors exit in panic and derail themselves from their long-term journey of wealth creation. In such a context, the benefits of close-ended funds not giving you daily liquidity actually come in play. Such a benefit is generic for all close-ended funds. This is an an added advantage of a close-ended structure.

Having put forth by arguments in favour of close-ended funds serving a specific need, many are replica of existing schemes and act as asset gathering machines. As a result, they don’t give anything different or unique to an investor. Now, that’s an example of a bad close-ended fund

To summarise, I would say that not all close-ended funds are good. Likewise, not all close-ended funds are bad. One really needs to deep dive and analyse each fund for its uniqueness, its context and its suitability at that point in time before passing judgement.

Such views have been presented in the India Markets Observer 2018, an online publication that brings together experts who discuss these challenges in the fund industry and investing insights and various perspectives.

Download your FREE copy of India Markets Observer 2018 Now!

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ramanathan dwarakanathan
Apr 19 2018 06:19 PM
I appreciate your views.
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