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Buying a close-end fund just because it is available at a discount to the NAV doesn't guarantee that you will make a reasonable return on your investment.

I am an investor who is used to open-ended equity funds. I have seen that Morgan Stanley Growth Fund trades at a 15-20 per cent discount to NAV and I am buying it steadily (like an SIP) to take advantage of the discount. I am willing to wait till maturity in 2009 as the fund has outperformed the index over a 7-year period. Kindly provide information on other closed funds that are traded on the exchanges, especially at a discount.

Pravin Varma

Mumbai

Most of the close-end funds that were listed on the exchanges have already been converted into open-end funds. The few that remain are not frequently traded on the exchanges.

Morgan Stanley Growth Fund is the only close-end fund whose units can actually be bought, on an ongoing basis, through the stock market.

We don't think you should buy a close-end fund just because it is available at a discount to the NAV.

The discount doesn't guarantee that you will make a reasonable return on your investment from a close-end fund.

The returns will depend on two factors — the fund's ability to deliver good returns in the years to redemption and stock market levels at the time of redemption.

If the fund substantially underperforms its peers or if the stock market is in a dull phase at the time of redemption, your returns may suffer.

The latter will hold true for any equity investment. But with a close-end fund, you do not get to choose the time of exit from the fund. Theoretically speaking, the fund manager in a close-end fund should be in a position to deliver better performance than is possible from an open-end fund.

Since close-end funds face no inflows or outflows during their tenure, the fund manager will not be forced to churn his portfolio at inconvenient times. In practice though, the performance of the Morgan Stanley Growth Fund has lagged behind several of its open-end peers.

To illustrate, had you invested in the Morgan Stanley Growth Fund at its NAV five years ago in July 2000, the fund would have, by now, delivered an absolute return of about 101 per cent (assuming reinvestment of dividends).

Over the same period, Franklin India Bluechip Fund has returned 169 per cent, HDFC Top 200 Fund has generated 232 per cent and HDFC Equity Fund has managed 234 per cent.

Though the Morgan Stanley Growth Fund has comfortably outperformed the Sensex and the broad market, it has not been the among the more attractive investment options available in the fund space.

The fact that you acquired units at a discount to the NAV will add to your investment returns. But with the discount narrowing considerably now, this will provide less of a cushion on performance, going forward. Given that you acquired most of your Morgan Stanley units at a substantial discount to the NAV, we suggest that you hold on to your investment until redemption.

But for fresh investments, you should probably consider investing in the SIP of a good tax-saving fund such as Franklin India Taxshield or HDFC TaxSaver.

As investments in a tax-saving fund are locked in for a three-year period, they enjoy a fairly stable corpus and feature only retail investors, offering several of the advantages of a close-end fund.

(Queries may be e-mailed to mf@thehindu.co.in, or sent by post to Business Line, 859-860, Anna Salai, Chennai 600002.)

Aarati Krishnan

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