When do the investments in mutual funds mature?

What is the maturity date of my mutual fund investments? When can I get the money? Read my article in Mid-day Gujarati edition today:

What is the maturity period of mutual fund investments? Can I withdraw on a premature basis? How?

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The English translation is as under:

What is the maturity period of mutual fund investments? Can I withdraw on a premature basis? How?

In some of our earlier article, we have covered the two chief varieties of mutual funds – open-ended funds and close-ended funds. While the latter have a defined maturity period, the former does not have.

The close-ended funds mature on a pre-decided maturity date.

Each scheme may have a different maturity period, just like in case of fixed deposits. The fund house would not encourage any redemption request prior to the maturity period. In other words, there is no premature withdrawal facility in case of close-ended funds. At the same time, on maturity, the investor would get the money back. The scheme cannot hold the investors’ money after maturity of the scheme.

The regulator has made it mandatory for the units of all close-ended funds to be listed on at least one recognized stock exchanges. This is in order to offer an exit route to investors before the scheme’s maturity. However, the trading volumes are very low and hence, though the facility exists, one cannot really get out of a scheme through the stock exchange mechanism. In that case, one should invest in close-ended funds only to the extent of money that can be kept under lock-in.

Open-ended funds are perpetual investment vehicles, in that there is no defined maturity period. Very simply, since there is no maturity period, there is no question of a premature withdrawal. In that case, how and when can one withdraw money from an open-ended fund? Well, simply by filing a redemption request for the amount required, i.e. partial or full, one can take the money out of a scheme on any business day.

First of all, the redemption form is a simple one that requires the investor to fill in the scheme name, folio number, amount (or units) to be withdrawn and put a signature.

If you are transacting electronically, i.e. through website, mobile app or through on of the industry platforms, you do not need to fill up or sign any redemption form. This means, you need not put your signature, but there could be password protection. All the other details like for folio number, etc. must be provided.

One has to take care of the exit loads and taxes. Some schemes may have an exit load if the investment is withdrawn before a certain time period. The taxes depend on the type of the scheme and when one is taking the money out.

The procedure is really very simple and offer great convenience.

Whether equity or debt - invest only after considering the risks ...

Whether you want to invest in equity or debt - please consider the risks involved. Understand the risks and manage these. Here is my article in Mid-day Gujarati explaining the risk involved in debt securities and debt funds:

http://epaper.gujaratimidday.com//epaperpdf/gmd/25072016/25072016-md-gm-12.pdf


The English translation is as under:

Last time, we discussed about one of the risks involved in debt securities and hence in debt funds. This time around, we would discuss another of the risks that exists, but majority of the retail investors are not aware of it.

In the debt market terminology, this risk is know as “interest rate risk”. In order to understand this risk, let us take the example of a debenture issued by a company.

This debenture was issued for a period of 5 years or the maturity of the debenture at the time of issue was 5 years. Two years have passed since and hence the debenture would now mature in 3 years.

Assume that this debenture is rated AAA – highest safety

Its face value is Rs. 100 and it bears coupon of 9% p.a. payable annually. This means the debenture holders would be paid Rs. 9 (9% of the face value of Rs. 100) every year for each debenture they hold.

Now assume that for some reason the interest rates in the economy come down – we have seen this happening in case of bank fixed deposits or recently in case of small savings or PPF – by 1% p.a..

This means, similar debentures (AAA rated debentures with a maturity of 3 years) would be available in the market offering a yield of 8% p.a.

Now when other debentures offer 8% p.a. and our original debenture, which was issued earlier is offering 9% p.a. That makes it more attractive compared to other debentures in the market.

Due to this attractiveness, investors would want to buy this debenture (We have assumed that such a debenture is traded in the stock market). This buying interest results in the rise in the market price of this debenture. The market price of such a debenture would rise to such an extent that now the return on investment in this debenture would fall to 8% p.a. Calculations indicate that the market price should rise to Rs. 102.58 per debenture.

This means that when you invest Rs. 102.58 in a debenture; earn interest income of Rs. 9 per year and get a maturity value of Rs. 100; the return on investment would be approximately 8% p.a.

On the other hand, had the interest rates gone up in the market to, say 10% p.a., our debenture’s market price would have fallen to Rs. 97.51.

As can be seen from the above example, the market price of an existing debenture falls when the interest rates in the economy go up. At the same time, a drop in the interest rates in the economy results in rise in the market price of existing debentures. Thus, there is an inverse relationship between the market price of existing debentures and the interest rates in the economy.

Now, assume the same company had issued another debenture at the same time, but for a maturity period of ten years. Hence, when two years passed from the issue of both these debentures, the two debentures would have a residual maturity of 3 years and 8 years, respectively.

If the interest rates fall by 1% p.a., one debenture offers higher interest for 3 years, whereas the other offers higher rate for 8 years. Thus, the relative attractiveness of the second debenture would be even higher and hence, the market price of the same would rise much more than the first one.

This is another fact that one should remember in case of debentures. Debentures with longer maturity witness bigger price changes when interest rates in the economy change.

The investors, who hold the debentures till maturity, do not have to worry about these changes in the market prices. They are unaffected by such changes. However, if someone needs to sell the debentures in the market before maturity, such an investor would be concerned with changes in the market prices – especially if the interest rates rise, causing the market price of the debentures to fall. At the same time, if the same investor continues to hold the debenture maturity, one would get the maturity value, as this is the contracted value.

While the debenture holders may hold the debentures till maturity to avoid the interest rate risk, debt mutual funds cannot. As we have seen earlier, the investors in (open-ended) mutual funds are allowed to transact at NAV linked price on all business days, the calculation of fair price must happen on a daily basis. For this purpose the NAV calculated on a daily basis must value all the debentures at the prevailing market price. Hence, an investor investing in a debt fund may witness frequent changes in the NAV of the fund. Having said that, such an investor would be better off holding the fund units for a recommended holding period in order to reduce the impact of interest rate risk.

A debt fund investor can also decide how much interest rate risk one wants to take. As we saw some time ago, debentures with longer maturity are more sensitive to changes in interest rates compared to those with shorter maturities. An investor can check the average maturity of a debt fund and decide to invest in one with low average maturity in order to avoid interest rate risk. An aggressive or a savvy investor, willing to take the interest rate risk may choose a debt fund with long average maturity. The details of a fund’s average maturity may be seen from the fund’s fact sheet.

Understand the risk in debt funds and take an informed investment decision.

-        Amit Trivedi

The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.

Moneycontrol chat 11-May-2015

Below is the link to my chat on www.moneycontrol.com today

Moneycontrol chat session

My views on proposal to ban upfront commissions

The article carries my views on proposal to ban upfront commissions:
http://cafemutual.com/News/AMFI’s-proposal-to-ban-upfront-commissions-draws-flak-from-many-distributors~3401~New~Industry~21

Understanding close-ended mutual funds

My article published in Mid-day Gujarati, Mumbai edition today.

The English translation is as under:

“Should I invest in this new mutual fund scheme?” Someone asked me the other day. This person was referring to the launch of a New Fund Offer (NFO) of a close-ended mutual fund scheme. This is not unusual. So many investors worry about investment decisions and tend to check on the schemes being heavily advertised. This may result into them missing out on some good schemes only since these are not advertised enough and information may not be easily available.

Let us come back to the NFO of this scheme. We have dealt with NFOs in one of our earlier articles. However, this time we are looking at NFO of a particular category of mutual funds, the close-ended funds.

To make it simple to understand, let us start with the difference between the terms (tenure) of these two categories of funds – open-ended funds and close-ended funds. The open-ended funds do not have a specific date of maturity, whereas the close-ended funds have. This means, these funds are wound up after a particular date (the maturity date) and the money is returned to the fund’s investors. On the other hand, the open-ended funds continue to operate perpetually.

Close-ended funds differ from the open-ended funds in offering liquidity to the investor. In case of open-ended funds, an investor has the facility to get out of the scheme on any business day. This can be done through submission of a redemption request with the fund house. Close-ended fund do not offer such a redemption facility. However, SEBI has made it mandatory to offer an exit route for the investors through the stock exchanges. This means, the units of close-ended funds have to be compulsorily listed on a recognized stock exchange. At this stage, it must be clarified that listing on a stock exchange does not mean liquidity, which is a function of the trading activity in the units of a specific fund on the stock exchange. Experience suggests that there is hardly any liquidity in the units of close-ended funds.

Where do these funds invest? Well, the mutual fund companies have launched various kinds of close-ended funds – equity funds, debt funds and hybrid funds (those that invest in both equity and debt).

The close-ended funds investing in debt are popularly known as FMPs or Fixed Maturity Plans. These funds are often used in lieu of fixed deposits simply as the mutual fund schemes have a slight advantage over fixed deposits – the returns are more tax-efficient. Though the last budget reduced some of the tax advantages to these schemes, these are still better if the investment is for more than 3 years.

The hybrid funds come in mainly in the “capital protection oriented” structure. In such funds, the primary objective is to protect the investor’s capital over the term of the fund. The second objective is to generate returns higher than traditional fixed income products. However, since these are close-ended funds, the equity component must generate superior returns exactly matching the term of the scheme for the secondary objective to be fulfilled.

The equity funds need more attention. Many investors prefer to invest in these schemes with certain assumptions: (1) this is an NFO, and (2) a close-ended fund offers better flexibility to the fund manager since there would be no redemptions. Distributors prefer to sell these schemes due to high commission income. All these reasons may not be correct. An NFO does not mean better investment performance. History does not support the argument that close-ended funds are able to outperform their open-ended counter-parts.

On the whole, it is always advisable to avoid these schemes considering the lack of liquidity. The funds with equity exposure – equity funds or hybrid funds – suffer from the fact that one does not know exactly over what period the equity would generate good returns. Equity, as an asset class, is always unpredictable – this must never be forgotten.

- Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions. He can be reached at amit@karmayog-knowledge.com