When opportunities don't present themselves

How to read the signal that your mid-cap or arbirage fund is likely to stop fresh inflows.

In the past one-and-a half decade, mutual funds (MFs) have started offering a wide range of products. In the quest to increase their assets under management every few years, a new category is added to their existing portfolio. Arbitrage fund, is one such example, from the recent past. From one fund in 2004, there are 20 funds today.

However, while asset management companies often goad you to invest in their schemes, there are times when they stop inviting fresh money into their schemes. This happens, especially, in the case of mid-cap and arbitrage schemes.

In such a scenario, many investors find themselves clueless for they want to take advantage of a rising or a falling market. But the opportunity is lost as scheme refuses to take fresh money.

As an investor, one needs to be prepared for such situations. Here's some help:

Sudden Stop: Fund houses stop accepting fresh investments in their open-ended schemes only for a specified time period. Sometimes, this happens when the fund size either grows too large or the investment choices in the market have narrowed.

In India, this situation has been witnessed in schemes that invest in mid-cap stocks, as well as even arbitrage funds. Often, large inflows into the schemes, resulting in a very large asset size, have made it difficult for the fund to conduct activities normally.

When the stock market started correcting in January 2008, many fund houses sold their investments and sat on a huge pile of cash waiting for markets to stabilise. It made little sense for them to take in additional funds as it wouldn't be put to the right use.

Warning Signs: Most fund managers will agree it is easier to manage a small fund as compared to a very large asset base, because providing high returns on a high base is a challenge. Investors who are looking to make use of the opportunity in the market often follow the herd mentality and rush to a particular area to get returns. These opportunist investors can redeem when the window of opportunity closes. Large outflow can hamper the performance of a scheme, and so, AMCs may close subscriptions.

Investors can look at some cues to judge if a scheme could stop taking fresh money. Firstly, this happens when there is a large build-up in the corpus of a scheme. For example, a rise in the corpus over two months from Rs 600 crore to Rs 1,800 crore in an equity-oriented scheme, which invests in small- and mid-cap stocks, should be a warning that the fund might stop accepting new applications.

Obviously, this may not be true for all such funds. But in such a situation, if the investor wants to invest, he should act quickly and make the necessary purchases.

In situation when there is a large run-up in prices of an asset, investment opportunities for fund managers narrow down. This is another cue. But in such events, investors should voluntarily stay away as the valuations would be too high. It also means that opportunities available for a particular type of scheme will begin to decrease, and the returns will be sluggish.

WHAT TO DO
But don't let fund houses suspending new subscription dampen your spirits. If you cannot enter into a large scheme, there will always be well-performing smaller funds that will require fresh inflows. Look for such funds and invest in them after going through the AMCs reputation, schemes' history, investment style and mandate.

But if you want to stick to a particular fund, and it has put inflows on hold, there is no option but to wait till it starts again. In a way, this will also ensure that the fund manager's fears are dealt with and the scheme is ready to make use of the available opportunities.

The writer is a certified financial planner