“Closed-end funds allow fund managers to take concentrated positions”

November 22, 2013 . Vidya Bala

Reliance mutual recently  launched a closed-end equity fund – Reliance Close-Ended Equity Fund. This five-year closed-end fund will be managed by Shailesh Raj Bahn, who also manages one of the top performing funds, Reliance Equity Opportunities. The NFO closes on November 29.

shailesh has a Q&A with the fund house on the reason behind launching this fund and how distinct it would be from other schemes in the stable.


What is the reason for launching a close-ended equity fund now?

The last few years had been quite challenging for the equity markets due to the global slowdown and the subsequent negative impact on the Indian Economy and stock markets.

The stock markets have recovered a bit in the recent past (S&P BSE Sensex closed at 21209 on 31st Oct, 2013, one of the highest closing levels) due to the recent improvements in certain macro parameters. However, the rally is quite concentrated and skewed.

We believe such skewness and narrowness of the markets have left behind lots of good quality companies with sustainable business models & proven track records at low absolute valuations. We expect some of these ideas to do considerably well over the medium to long term.

In order to capture some of these opportunities, we are launching Reliance Close-ended Equity Fund – Series A. Close-ended format would allow the portfolio manager the flexibility to execute the strategies effectively over the chosen time frame – in this case, over 5 years.

Further, the portfolio could be constructed based on the market merits, without possibly getting impacted by external flows. Close-ended funds also allows fund managers to take concentrated positions in stocks / sectors and possibly offer portfolios that may be distinct and unique from other open-ended funds.

Indian markets have roughly seen 8-year cycles, topping the charts in 1992, 2000 and 2008. Do you think we are therefore still not at the verge of a recovery?

The last few years have been truly exceptional where we have witnessed a few ‘black swan’ events leading to unprecedented outcome such as the mortgage crisis in the US, Sovereign debt crisis in the Europe and much of the economies, including emerging economies like India getting impacted. It may not be appropriate to draw inferences about future market movements, based on the past, particularly based on the last five years.

In our opinion, some of the factors plaguing the markets in past 5 years are likely to be different in the next 5 years:

US recovery in contrast to US recession of 2008

  • The US recovery is expected to be in full swing by 2015
  • Likely to aid other developed markets to get back on their feet, which, in turn, is expected to push export growth within emerging economies

Flattening of oil prices in contrast to rising oil prices

  • This would  relieve pressure on tight government finances and contain the current account deficit
  • Fuel-led inflation likely to be under control
  • The resultant INR stability key for stable capital inflows

Domestic reforms, such as liberalization in FDI in retail and pensions, in contrast to lack of reforms

  • Key Bills passed in recent times – Land Acquisition and Rehabilitation Bill, the Pension Bill, & Companies Bill
  • Other reforms on the way – Undoing the retrospective tax changes, FDI in multi-brand retail

On the whole, we may see the next five years as bringing in the third round of liberalization measures that may help the economy get back on its potential growth track.

We think this is very good time for long term portfolio construction for the following reasons:

  • GDP growth estimates have been toned down to 4 – 4.5%
  • Corporate profit margin has fallen to low of 6.1% (for top 418 companies, Ex Financials), which is close to low of 5.9% it touched in FY 2002
  • Valuations for midcap companies are at the lows  of 2001
  • Equity allocation is at all time low as investors are overweight in gold & real estate (both these sectors are showing signs of fatigue)
  • G-Sec yield close to 9%, it peaked at similar level in Mid 2008 and then declined to 5%
  • INR Depreciation
  • Elections are around the corner – investor expectations are close to all time low
  • Government is pushed to the wall (that’s when it acts)
  • Twin Deficit
  • Fuel price hike (no choice left)
  • Policy paralysis
  • Fear of rating downgrade
  • India has had one of the best monsoon in last 35 years, agriculture growth set to rebound sharply – rural demand to be strong – market is ignoring this

In addition to these fundamental factors, polarized valuation offers good investment opportunity in 101 to 500 ranked companies and offers tremendous opportunity for alpha creation.

What segments/sectors in the market do you currently see opportunity?

Given the market distortions, where 2/3rd of the markets are trading way below their peaks and 1/3rd of the markets is below even their 2009 lows, we are positive on a few sectors like Engineering, Capital Goods, Auto, Auto ancillaries, Midcap IT, Midcap Pharma, Retail and Media, where good stocks are available for attractive valuations.

With interest rates not showing much signs of moving southward, is there a risk of debt and interest servicing pressures hurting corporate financials further? 

We believe we are at the fag end of a rate hike cycle and RBI would once again embark on taking pro-growth measures, which will support yield going forward and keep interest rates in the system relatively low. Some of the positives for the markets are as follows:

  • Expected listing of India’s sovereign debt on leading international indices will attract $15 – 20 billion of FII flows every year into the Indian Debt market.
  • RBI has already conducted three Open Market Operation (OMOs) purchases of around Rs 22,400 crore since August end. As RBI injected additional daily liquidity of around Rs 20,000 cr recently through term Repo, we do not expect OMOs immediately. But once policy rates are normalized, RBI will start OMO purchase again as liquidity is expected to remain tight (due to continuous supply in Nov and advance corporate tax outflows in Dec). OMOs would further support yields at the longer end of the curve
  • The RBI has revised trajectory on Inflation (WPI around 7% & CPI around 9%). If the food prices fall substantially in winter there is a possibility of inflation surprising positively.
  • Improving global macro scenario and dovish FED stance with further postponement of Quantitative Easing (QE) might increase portfolio flows into the country.
  • Improving sentiments prior to elections would start reflecting on the forex as well as the equity markets and prompt additional portfolio flows into the country easing liquidity in the system.

Is Reliance Closed end Equity likely to have a mid-cap bias? 

The fund is expected to have 70-80% exposure in midcaps, considering the narrowness of the market movement where much of the broader markets have been left behind leaving lots of opportunities where good businesses are available at attractive valuations.

These midcaps would mostly be larger midcaps.  The stocks would have to fulfill the investment framework of having solid well-established businesses and other sustainable business characteristics and yet available for attractive valuations. The Remaining 20-30% would be in large-caps.

How different is this fund going to be from your open-ended diversified funds such as Reliance Equity Opportunities?

The fund would be quite different from any other open-ended fund. Following are some of the USPs of the Fund:

  • The Fund would be benchmark-agnostic. i.e., it may not mirror the benchmark. It may take significant deviation from the benchmark to invest into stocks fitting into the framework of the Fund explained in the previous question. The approach is very different from that taken by most open-ended funds, which are managed very close to the benchmark.
  • The fund will focus on absolute valuations and alpha generation.
  • The fund may hold significant positions in a few stocks that have solid businesses and yet are available at attractive valuations.
  • The fund would endeavor to pay substantial dividends under the Dividend Payout option, depending on the opportunities and the market scenario.

6 thoughts on ““Closed-end funds allow fund managers to take concentrated positions”

  1. those who are interested in speculation should invest in the is not for ordinary investor.

  2. I agree. lots of these ideas mentioned by shailesh can be done in their existing scheme as well.

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