Dec 29, 2014 01:15 PM IST | Source:

Why invest in a closed-ended mutual fund?

Investors subscribe to the thought that they make money if they remain invested for long term. However in practice most investors panic in short term. Closed ended structure helps investors to stay put in equity for longer period of time.

Sunil Subramaniam
Sundaram Mutual

Closed ended funds have in recent times become quite the apple of fund houses’ eyes with one launch after another.  As an investor, you may be wondering if it makes sense to be parking your hard earned money in these closed-end funds.

To answer this question we need to look at the purposes behind your investment and the practical evidence from past data.

The table below shows the typical range of answers that investors give when asked about the primary motive behind their investments:


Figure 1: Source: customer survey undertaken among Sundaram Mutual fund investors

As seen, almost half the investors identify ‘long term wealth creation’ and ‘provision for old age and retirement’ as a goal of the investment decision. Study of market performance data reveals that the probability of long term wealth creation rises dramatically with the length of time that one stays invested in a particular fund, asset class or market.

The graph below shows the minimum returns enjoyed by investors who stayed invested in a NIFTY index fund for various periods of time:

Figure 2: Study of daily rolling returns over the last 19 years of the Nifty. Source –Source – In house Analysis; Bloomberg Inception – 1 Jan 1996 Data representative of CNX Nifty Index

As seen, across a 19 year timeframe (covering both bull and bearish phases of the stock market) the minimum returns an investor obtained dramatically improves with the length of the investment period and he never ever lost any money if he had stayed invested for a period longer than 7 years.

A related graph (shown below) also demonstrates the same point from a different perspective: the probability that an investor suffers an erosion of his initial capital also greatly reduces with the increasing tenure of his investment.

Figure 3: Source – In house Analysis; Bloomberg Inception – 1 Jan 1996 Data representative of CNX Nifty Index

Thus staying invested for the long term is what improves the probability that some of the investor’s stated goals of ‘wealth creation’ are actualised.

So investors should ideally be staying invested for longer periods of time. However an analysis of actual investor behaviour throws up some contradictory results.

Figure 4: Proportion of customers staying invested in fund over time; Source: Behaviour of existing Sundaram investor base

As seen from the graph, more than 30% of investors redeem their investments within one year and only 22% remain invested at the end of year 5!!!

Clearly investors tend to act differently from their stated objectives!! Naturally there are a number of investors who experience disillusionment with their mutual fund experience!!
Why do investors act thus?? One answer could be that in answering a questionnaire they think logically but when they make practical decisions they are driven by their emotions – of either ‘greed’ at booking profits or of ‘fear’ at experiencing losses or being influenced by so called experts!!

Herein lies the genesis and logic of closed end funds – By locking in an investor for a minimum lengthy period of stay (and preventing them from reacting on an emotional level), asset managers are hoping to ensure that a larger proportion of them experience positive returns from their investment decision and thus build up an increasing base of Happy Investors!

Asset Managers also aim at declaring regular dividends as and when markets (funds) rise sharply, thereby returning as much of the initial capital as possible during the tenure of the fund. Hence, creating happy investors!

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