Sunday, April 30, 2006

Closed ended mutual funds

Closed ended mutual funds provide exciting opportunity to make
handsome gains if you buy them at a discount.

A close-ended fund or scheme has a stipulated maturity period e.g. 5-7
years. The fund is open for subscription only during a

specified period at the time of launch of the scheme. Investors can
invest in the scheme at the time of the initial public

issue and thereafter they can buy or sell the units of the scheme on
the stock exchanges where the units are listed.

The market price of the listed closed ended fund generally trades at a
discount. The discount depends 4 variables.
1. Time left till redemption date : N years
2. Interest rates : y% per ammum
3. Expectated annualized returns : g% per ammum
4. Expected Dividends : d

For simplicity if you ignore variable 3 & 4 then the market price can
be calculated as follow.
Assume Market Price is P
NAV = P * [ (1+ 0.01* y) ^ N]
^ stands of power

As you know the NAV and price you can calculate what interest rate is
built into the prices.

For instance NAV of Morgan Stanley Growth Fund(MSGF) is Rs. 18.81 and
the market price is Rs. 13.85. As there are still 4.5

years left till date of redemption the prices are factoring in 7.04%
interest rate. In simpler terms if you buy MSGF today

and its NAV remains same on Feb 2009 then you would still get 7.04%
returns (- transaction costs ofcourse..)

However the factors which we ignored also play a significant role in
pricing of closed ended mutual fund. For instance in

2001-02 UTI crisis the UTIO mastershare was quoting at amazing 30%
discount to NAV with only 2 years left to the

redemption date. I kept accumulating this fund throught the crisis
days with significant transactions as given below.

25-Jul-01 Buy 3000 9.65
3-Oct-01 Buy 5000 6.6
22-Apr-02 Buy 5000 9.35
The average price comes to 8.36 and it now quotes at 17.25 after 2

At that time Sensex was quoting at 2700 -3000 range. As my
expectations were that in 2 years the market will be quoting

higher than these levels I knew that I stand to gain much more than
the discount at which I was buying. Let me explain this.

Assume a fund is quoting at pice 'P' and has NAV as 'NAV' and it given
returns of G% p.a. Let's assume the redemption date is

N years from today.

On redemption date NAV would be => NAV * [ (1 + 0.01* g) ^ N ]
=> NAV * (G^N) where G is (1 + 0.01* g)
You bought the fund at price P.
your returns is => [ NAV * (G^N) / P] ^ (1/N)
Now NAV/Price is the discount.

That means that your per annum returns gets boosted by a factor of
[NAV/Price] ^ (1/N).

The mastershare mutual fund gained cumulative 61% but my returns were
higher at 130% due to the discount of 30%. Please note

that the returns that I got were higher that simple addition of return
of mutual fun and discount (i.e. 130 > 61 + 30).

Thus if you are bullish on the market in general buying a closed ended
fund at discount gives extra returns and ensures lower losses in case
the markets go down. However it is very important to check the
portfolio of the fund, the management costs,exit loads and brokerages
before buying a closed ended fund.

For more information on closed ended mutual funds click the following

Title : A Brief Guide to Closed-End Funds

Posted: Aug 11, 2004

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