It's tough to buy closed-end funds at exchanges

Just a couple of days ago, HDFC Equity Opportunities Fund II, a closed-end fund, was quoting at a discount of 14.76 per cent to its net asset value at the stock exchange — an attractive proposition for any investor. There are a number of other closed-end schemes, both debt- and equity-oriented, which are trading at a good discount of 9-12 per cent. And some are maturing in 2018, making them attractive investment options for a short period for the high net worth individual (HNI). The question is — can an HNI or even a retail investor buy such schemes from the exchange? The answer is usually no, according to experts.   

So, what is a closed-end scheme? It is a mutual fund scheme with a lock-in of three-five years. And due to the lock-in, fund houses have to mandatorily list them at the exchanges. The listing is expected to give these schemes liquidity for an investor who wants to exit or redeem units of the scheme. In comparison, an open-end scheme does not have any lock-in, so redemption is possible anytime. 

Hemant Rustagi, chief executive officer, WiseInvest Advisors says: “Unlike a stock in which regular trading takes place and the price is arrived at through demand and supply conditions, there isn’t much trading that takes place in closed-end schemes. This leads to a lot of price distortion. Any investor who sees huge discounts between the net asset value and trading price would be interested in buying such funds. But it is doubtful if there would be sellers at that kind of discount.” 

The same problem exists for sellers as well. “It is not that only buying is difficult, even exiting closed-end funds at the exchanges is not easy. Unless you have a broker who can get a client who is interested in buying, something that may take weeks sometimes, it is almost impossible to exit these schemes,” said a fund manager who did not wish to be named. 

Besides the difficulty in buying and selling, another point that goes against buying closed-end schemes maturing in the next one-two years is the tax aspect in case of debt-oriented schemes. With the change in taxation norms, a debt scheme has to be held for three years to get indexation benefits. Investors get an inflation indexation benefit, which reduces their tax outgo on capital gains significantly, during high inflation periods. However, if they exit the scheme in less than three years, the capital gains are added to their income and taxed according to their income tax slab. For HNIs, who come in the 30 per cent-plus-cess bracket, the hit can be significant. 

Financial planners, consequently, do not recommend closed-end schemes too aggressively unless the investor is very conservative and can stay invested for the entire tenure. “Getting into such schemes for a quick buck has become difficult for investors because of the change in tax laws. If you have not participated in the new fund offers of such schemes, it does not make sense to look for an opportunity at a later date. Either stay the entire period or don’t get in at all,” says a fund manager.