Shakti Ballab Koirala |21st May, 2021|
Value stocks in bull market are immensely rare. At the height of current bull rally, when investors are eying banks for undervaluation, there is an entire sector trading at discount. This article is about closed end mutual funds, available discounts, possible reasons and meaning for the investors.
What are mutual funds?
Mutual funds are professionally managed investment scheme that pools money from public and invest in different securities to meet investment objectives. They are popular worldwide by offering benefits such as diversification, liquidity, professional management and tax benefits.
Mutual funds don’t have much long history in financial market of Nepal. It started with the flotation of NCM Mutual fund 2050 by NIDC capital market. However, the formal inception happened only after the introduction of Mutual fund Regulations 2067 and Mutual fund Guidelines 2069. As of Baishakh 31st 2078, there are 20 close ended mutual funds in operation (Nepal Stock Exchange [NEPSE]).
Close ended mutual funds and available discounts
Close ended mutual funds as name suggests are closed in nature. Meaning that they have fixed amount of fund and predetermined maturity period. They are regularly traded in NEPSE like common shares of any other listed companies. The market price of close ended mutual fund may be below or above their Net Asset Value (NAV), creating discounts or premium. Its discount, if market price is lower than the NAV and premium if vice versa.
As of Baishakh 31st 2077, all of the mutual funds are traded at discount in NEPSE. For instance, with a NAV of Rs 17.9 and market price of Rs 12.6, NIC Asia Growth Fund (NICGF) is trading at whooping discount of 30%. Imagine you have Rs 1.06 Arab which is almost equal to market capitalization of NICGF. Now keeping other things constant, you can buy all the units of mutual fund at market price and sell its assets at profit of 30% in between. However, in reality there are certain limitations and associated costs to do so.
Mutual funds are trading at discounts when overall market is bullish and companies in every other sectors are traded far above their net worth. Many investors aren’t aware of this phenomena, some find it normal while other take this out of ordinary. No matter what, it is definitely something considerable for an investor.
Why discounts exist?
Mispricing of mutual funds isn’t something happening only in Nepal but are pervasive across the world. Discounts in closed end mutual funds is an ongoing puzzle for researchers as well. Proponents of EMH suggests that the deviation exists because of various market imperfection like agency cost, illiquid assets and tax factors. Similarly, behavioral theorists explain the deviation to be the result of emotional difference between rational and non- rational investors.
On a practical note, the recent mutual fund discounts in NEPSE can be attributed to these different factors of demand and supply.
- History of poor performance
Many mutual fund were launched around and after the peak of 2016 bull cycle. The following bear cycle led to poor performance and returns from mutual fund. The anchoring bias among investors on history of poor performance could have refrained them to invest in mutual funds.
- Lack of knowledge on mutual funds
The number of new investors have grown tremendously within this past one years. Many of this new investors as well as existing are less aware about mutual funds, their business model and trading process. Due to this, there seems less attraction for mutual fund units in secondary market.
- Low liquidity
Mutual fund occupies 6.2% of total market share, however their average daily turnover remains less than 1% of total market turnover. Especially, traders and big investors mayn’t find counterparty to trade desired quantity of units at given time. Due to this- lack of liquidity, mutual funds have less demand ultimately lowering their price.
- Pessimism regarding future performance
Mutual funds mainly earns from return on investment in stock market. As NEPSE has already surged to a level of valuation over the period, investors could have been pessimist about further NEPSE movement, ultimately incorporating it in price.
- Investors perception
There are investors who view that mutual fund discounts is justified as majority of their earning is unrealized. Some investors believe that they would be better off by buying mutual funds holdings rather than their units while other are suspicious about governance of funds. These sorts of perception certainly put pressure on demand side.
The Bottom Line
Mutual funds are subject to high market risk but the prevailing discount have provided a good margin of safety for the investors. Some experts find this scenario as a clearance sale at their favorite store; and are loading mutual fund units in their portfolio. The discounts may lower in upcoming days as funds materialize their earnings.
- NEPSE. Nepal Stock Exchange Ltd.
- Mutual Fund Rules 2067. Retrieved from Mutual_fund_Rules_en_2067.pdf
- Mutual Fund Guidelines 2069. Retrieved from Mutual Fund Guidelines 2069.pdf
- Koufadakis, S. (2016). Mispricing Explanations of Closed-End Funds: A Survey Review, SPOUDAI. Journal of Economics and Business, 66(1/2), 108-135