It is all about icapital.biz Berhad (ICAP, 5108) (Part 2)

After investing into ICAP, I have further involved into ICAP by subscribing its affiliate magazine “i Capital” and attending ICAP’s annual general meeting (“AGM”). There were several significant points that I learnt from ICAP after investing its shares which reinforce my understanding how the fund is functioning. The fund is encouraging its shareowners to hold the shares with a long-term basis.

In order to encourage investors to be long term shareowners for a fund, the fund can impose several restrictions to the fund such as 1-year lock in period, 2-month disposing notification period and close-end units. So ICAP decided to setup the fund with a close-end basis. The subsequent paragraphs I would like to differentiate what is a close-end fund (“CEF”) and its different to an open-end fund (“OEF”).

A CEF is set up as a company under the Companies Act and is generally listed on a stock exchange. CEF has a fixed number of shares outstanding and its capital is raised through an initial public offering (“IPO”) like any other public offerings. Investors who buy the shares of a CEF will become shareholders of the company. Like all other publicly traded securities, shares of a CEF are bought and sold in the open market. Its share price is determined by supply and demand in the marketplace.

Whereby the OEF, or more commonly in Malaysia it is so-called the Unit trust funds (or in the US it is mutual funds) which is not incorporated as a company but as a trust where monies are collected from investors to be invested and managed for investors' benefits. OEF’s units are first offered through an IPO. However, OEF units will vary even after the IPO. As the unit holders of OEF are still able to buy or sell theirs from/to the OEF, and the OEF is responsible to issue new units for buyers and cancel its existing units to liquidate cash in order to meet the unit holder’s redemption. Sometimes, some of the fund mangers of certain OEFs claimed that their fund size have increased a lot during a short period, however please take note that the increase of the fund size not necessary because of the fund manager’s ability to achieve superior return but just merely indicates that there are more units being issued.

In view of the abovementioned difference in between CEF and OEF, I would like to point out the one of the most important advantages that CEF consists is the professionalism of fund manager is retained much better than OEF.

Why we want to invest a trust fund? The most common pitch used by trust fund is that it allows the man in the street to enjoy professional fund management. However, due to the open-end structure of an OEF, the investment decision making is indirectly made by the retail investors, not the professional fund manager. Investors themselves end up being the one controlling the buying and selling of the fund's portfolio, not the fund manager.

When the stock market is bullish, investors tend to flood new monies into OEFs. When this happens, the OEF receives an inflow of cash and needs to invest the monies received based on their investment mandate. Thus, investors are 'forcing' the fund managers to invest, even when some of the shares are trading at high valuation. In a bear market, investors tend to panic and start to redeem or sell their units. Fund managers of the OEF have no choice but to liquidate their portfolio to raise cash to pay the investors who sold or redeemed their units. Thus, investors 'forced' fund managers to sell when the stocks may be trading at attractive valuation. Once the fund managers are ‘forced sell’ the stocks, it will trigger another round of market crashing and investors will be more panic and selling/redeem more units. So it is just a circle of market crashing, panic, selling and market crashing again. In short, the fund managers of OEF are dictated by the emotions of unit holders who are tend to be more in short-term tenure, and thus eliminating the benefits of professional management and long-term investing.

On the other hand, the buying or selling activities of the unit holders of CEF will not affect the investment decision of the fund manager once it is after the IPO. If any potential investors would like to buy the CEF’s units or any existing investors would like to dispose the CEF’s units after IPO, they can trade to buy/sell the CEF’s units at the secondary securities market such as Bursa Malaysia, and the CEF is not responsible to any of these trading activities. This is the reason why CEF is required to be listed at a secondary market for the ease of trading the units. Thus, the fund manager of CEF can efficiently utilise the proceeds from the investors for long term investing and buy more units during bear market with cheaper valuation and selling more units during bull market with higher valuation without disturbances from the trading activities carry by the unit holders. This is one of the reasons that CEF can outperform OEF in term of investment return.

(To be continued)