Mumbai: India’s Rs7.6 trillion mutual fund industry, seeking ways to counter a ban on entry loads they charged customers to pay for marketing and distribution costs, is bringing back closed-ended schemes that lock in investments for a predetermined tenure.

At least two fund houses have won regulatory approval to launch three tranches of such schemes each in the next couple of months. Birla Sun Life Asset Management Co. Ltd and IDFC Asset Management Co. Ltd are marketing the schemes as investment plans aimed at protecting capital.

Franklin Templeton Asset Management (India) Pvt. Ltd, which has been offering such schemes, currently has a similar plan open.

In a closed-ended fund, investments can be made only during the new fund offers (NFOs) and no new investor can apply to buy mutual fund units once the it closes. These funds have a fixed tenure and investors can liquidate their investments only on maturity.

Although these schemes are listed, they are illiquid, making withdrawals difficult and expensive. An investor cannot easily withdraw money in an emergency. Also, the investor can’t book profits and get out of the scheme even if he or she takes a view that the markets have peaked.

In August, market regulator Securities and Exchange Board of India (Sebi) barred fund houses from charging investors an entry load—a non-refundable charge that went to pay for marketing and distribution expenses.

Fund houses, prodded by distributors desperate for higher commission, are now turning to closed-ended versions in the hybrid space of products that invest in a combination of debt and equity, say industry executives. Such schemes allow fund houses to incentivise agents better as they are sure that the money will stay locked in for a fixed term.

The first tranche of schemes from Birla Sun Life and IDFC are already open for subscription. Subsequent tranches will be raised over the next couple of months, officials at these fund houses said. According to industry estimates, these funds are targeting between Rs2,000 crore and Rs2,500 crore.

Birla’s BSL Capital Protection Oriented Fund Series 1, which was to close on 5 March, has been extended to 10 March. IDFC’s Capital Protection Oriented Fund-Series 1 is open through 24 March.

Ashwin Patni, portfolio manager (structured products) at IDFC Asset Management, said the fund house plans to come out with such closed-ended schemes at regular intervals so that investors get used to these products and learn to use them as an alternative to fixed deposit investments.

The closed-ended category went out of vogue after Sebi in early 2008 abolished 6% amortization of issue expenses, typically spread over three-five years. Amortization is a process of recovering the acquisition cost over a period of time. Following the rule, not a single closed-ended scheme raised money until now, according to data from the Association of Mutual Funds of India.

While this move affected their attractiveness in the equity segment, the liquidity crisis in 2008, following which Sebi mandated compulsory listing of such schemes on the exchanges, made it redundant in the debt space.

Fixed maturity plans subsequently shrank to a trickle in 2009. From a peak of 569 schemes raising Rs1.16 trillion in 2008, just 55 new schemes raised Rs10,519 crore in 2009.

“Distributors, especially banks, prefer to sell new schemes for a fixed period and move on to new ones," said another senior official at IDFC Asset Management who didn’t want to be named.

Explaining their thinking, he added that they “prefer closed-ended schemes as these provide better value given that money stays for at least three years, earning them a better trail commission". Trail commission is paid to the distributor at the end of every year, based on the assets brought in.

Distributors are happy with such offerings as many of them opt for upfront commission, forgoing the trail commission. According to them, depending on the amount of mobilization, this ranges between 3% and 4%, of the total investment.

“These issues are good as the money is locked in for a fixed period, the trail income is assured. The fund house can also pay better upfront. Some even offer to pay the trail upfront," said K. Venkitesh, national head (distribution) at Geojit BNP Paribas Financial Services Ltd.

In contrast, in an open-ended scheme, investors are free to enter and exit any time. With Sebi placing restrictions on charging exit loads, fund houses are not sure of incentivising the distributor.

“Distributors and fund companies are pushing these schemes," said Dhirendra Kumar, chief executive officer, Value Research, a New Delhi-based mutual fund tracking firm, because “distributors get an upfront commission by selling these schemes, (and) the fund company has a premise to plan its investments for a longer term as these schemes come with a lock-in of three-five years."

In that period, he said, such funds can typically generate yearly returns of 8-12%.

In fact, commissions are the key drivers of such schemes, said a senior official at a leading asset management company, as it allows distributors to make up to 5% in upfront commission, and assures them of the safety of capital.

Closed-ended schemes may make life easier for fund houses and distributors, but they are not always investor-friendly.

“For an investor, money gets locked in for three-five years with little or no upside," said the asset management company official cited above. “There is a time value of money. If your money doesn’t grow for five years, then you are actually losing some value."

In closed-ended funds “money gets locked in, that’s a disadvantage, so from a business point of view, I still prefer the open-ended schemes," said Kanwar Vivek, chief executive officer, Birla Sun Life Distribution Co. Ltd.

However, “there is a short-term attraction in closed-ended schemes as the commissions are up to 50 basis points higher." One basis point is one-hundredth of a percentage point.

A closed-ended fund entails necessarily participating in an NFO every time. As a result investors have no track record or performance history for evaluating the scheme, and must rely on the fund house and its investment practices/processes before deciding on the investment.