Close-ended funds or ELSS Schemes?

By A. Balasubramanian
Chief Investment Officer
Birla Sun Life Mutual Fund
April 2007.
Mutual Funds have in the past offered close-ended funds, pre 1995, which were listed on the
Stock Exchanges and traded in the market just like an equity share. These units became very
popular due to their easy tradability and transferability. There were times, due to sheer
speculative activities, that these units traded at substantial premium to their Net Asset Value. This
speculation was due to the fact that the Net Asset Values of these schemes used to get reported
by Mutual Funds once in a month or once in a quarter, thus, leaving an element of estimation on
the NAV movements on the underlying funds portfolio.
Both well and ill informed investors used to participate in these offerings on expectation of listing
gains, however, as time passed, investors realised the importance of Net Asset Value and the
market price too got adjusted in accordance with the NAV. This phenomenon existed till probably
1992, since then open-ended mutual fund schemes became the order of the day akin to
international practices.
Mutual Funds were permitted by Government of India to float close ended mutual fund schemes
to cater to the tax paying segment of Indian investors. Mutual Funds used to float such Tax
Savings schemes with the permission of Ministry of Finance. It used to be an every year
phenomenon wherein MF would apply to MOF for the necessary approval to float such schemes
that would meet the stipulated investment guidelines laid out by the respective Ministry. On
receipt of the approval, Mutual Funds would keep the scheme open for 3 months invariably from
January till March end. There used to be predefined conditions attached to such proposals
wherein investments pattern used to be directed by the circular. However, as the market matured
and with the entry of more private players in the Mutual Fund space, Government began to relax
certain stringent norms that used persist in the early days of Mutual Fund industry. This is when
Tax Savings were modified in a such a way that Mutual Fund would need to get permission from
Ministry of Finance only once at the time of initial offering. In the subsequent periods, the same
scheme would be continued to serve the purpose of acting as a vehicle to investors to plan their
tax exemptions / incentives. Equity Linked Savings Schemes are generally open-ended schemes
for subscription; however, they are close ended for the purpose of redemption up to three years.
ELSS schemes are notified by the Ministry and Securities Exchange Board of India to be part of
the eligible scheme to invest under the specified Income Tax provision.
In the last ten year, Mutual Fund industry has grown in size in both in terms of numbers (AUM)
and number of investors. Mutual Fund players too have gone up during the same period. Mutual
Funds have been also been offering different products at different point of time to serve the need
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of investors.
As on 28 Feb 2007, Indian Mutual Fund Industry has got Assets Under
Management of Rs. 353,309 crores. This is a combination of debt and equity schemes. Indian
Capital market has also been evolving and getting better and better with introduction of trading in
derivatives, trading in securities in electronic form etc. While Mutual Funds have been offering
variety of funds under different categories viz. value, growth, value + growth, thematic funds,
sector funds etc, investors have been retaining the option of moving out at any given point of time
depending upon the need of the investors or their time frame of investments.
Equity Linked Savings Schemes provides an opportunity to Fund Manager to look at companies
that provide value as well as growth. Generally, there is a tendency to look at companies from
their long-term potential perspective.

ELSS schemes generally adopt a typical of way investing in equity wherein the Portfolio Manager
looks at long term potential of the company, sector and overall economy. The schemes provides
a window to Portfolio Manager in terms of not getting carried away by short term fluctuations in
the market, thus, outperforming the market eventually. The initial lock-in period of three years
provides an opportunity to Portfolio Managers to look at companies that could be real wealth
generators over a period of time. As Warren Buffet says All there is to investing is picking good
stocks at good times and staying with them as long as they remain good companies
Mutual Funds have now been offering close ended funds with different investment objective.
Some of the recent launches are essentially focusing on small and mid cap segment of the
market with clear direction on the segment of the market in which the investment can be made.
Unlike an ELSS scheme, close ended funds are open for redemption any time during the
currency of the scheme, albeit at some cost. The cost of exit would be equivalent to the
outstanding unamortised expenses per unit. However, ELSS schemes are designed in such a
way that the scheme has got a clear lock-in in the first three-year period and thereafter it
becomes an open-ended for redemption. Equity investments with lots of discipline tend to
generate superior return to investors over a longer term.
ELSS as a category is growing in size. As of February 2007, ELSS as a category has got assets
under management of more than Rs.7000crores. ELSS schemes have delivered superior
performance for the last many years. Birla Tax Plan 98 has gone up multifold compare to any
other open-ended or close-ended funds. Birla Tax Plan 98, as the name suggest, was launched
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in 1998. The scheme NAV of Rs.10/- in 1998 now stands at Rs.193.29 as of 28 February 2007.
This indicates the power of compounding for long-term investors.
Therefore, ELSS schemes provide an opportunity to both the investors and the Portfolio
Managers to truly follow the investment principle of long term investing for generating wealth.
ELSS scheme also provide a window of opportunity to save regularly through Systematic
Investment route to fulfill their annual requirement for saving tax under the current income tax
provision under Section 88. Any close-ended fund too provides a similar opportunity to both
investor and portfolio managers; however, the initial three-year lock-in period makes all the
difference in an ELSS schemes from the investors perspective. However, from Fund Manager
perspective, both the schemes would more or less adopt to an investment style that is driven by
bottom up stock picking investment approach rater than momentum or top down investment
approach.