Morgan Growth:15% off

FUND STRATEGY

Morgan Stanley Growth Fund units are among the best value buys available in the market today.

If you are among the 16 lakh investors who invested in Morgan Stanley Growth Fund when it was launched in 1994, you may not be in a mood to forgive the fund for the rest of your life.

But here is your last chance to make good your bad decision to invest in the fund a decade ago. Don't sell Morgan units now. And buy more, if you can.

In the first issue of The Smart Investor in 2005, we had recommended Morgan units as among the best value buys. Morgan units have gained 11 per cent while the the Sensex remained where it was.

The narrowing of the gap between the true asset value of Morgan units and its traded price makes it far less attractive than what they were worth three months ago. 
 

Morgan's big bet (Top 25 holdings by market value as on March 31, 2005, representing 76% of the total portfolio)
Name of the security	% of net assets
Bharat Heavy Electricals	6.83
Oil and Natural Gas Corp	5.09
Infosys Technologies	4.91
Hero Honda	4.48
HDFC Bank **	4.31
Siemens	3.89
ITC	3.84
ABB	3.76
HDFC	3.49
ACC	3.03
Wipro**	2.97
State Bank of India	2.60
Gujarat Ambuja Cement	2.43
Hindustan Construction	2.42
Container Corporation of India	2.39
UTI Bank**	2.34
Tata Consultancy Services	2.26
Cipla	2.02
Hindalco Industries	2.00
Punjab National Bank	1.98
Aventis Pharma	1.98
Tisco	1.81
SAIL	1.78
MTNL	1.74
Mahindra and Mahindra	1.65
Total Net Assets (Rs crore)	1544.00
** Includes local shares, ADRs and GDRs

Still, they are easily among the best value buys available in the market today. The fund's net asset value (NAV) is currently Rs 26.03 while its traded price at the bourses is Rs 21.63, a discount of 16.90 per cent.

The fund is due for redemption in 2009 and as it ages the gap between its traded price and asset value will minimise, unlocking the value hidden in the units. Simply put, if you buy Morgan units now you would make a return of 20.34 per cent, assuming that the asset value of Morgan units neither gain nor lose in the meanwhile.

Morgan Stanley Growth is a closed-end fund which is listed on the BSE and the NSE. Since the turn of the year trading volume has risen sharply to average daily turnover of 8,00,000 units.

Some shrewd investors, who were investing with the objective to monetise the discount around a year ago, and some others, who now find the return from the units at 'acceptable levels', are on the selling side as the discount has come down sharply over the past few months.

For someone who had invested in Morgan units in the initial public offer, the current market price would fetch an annualised return of 7.77 per cent without considering the dividends.

Adding back the four dividends totalling Rs 4 paid by the fund till now, the total return to investors would be 9.56 per cent. In terms of NAV, after adding the dividends, the fund has produced an annualised return of 11.26 per cent since launch.

If you have faith in the Morgan's fund management - that it would do better than the market under all circumstances - you could go a step further.

One can consider selling Nifty futures of equivalent value simultaneously, eliminating the market risk. So when the fund matures you pocket the discount and the excess return that the fund produces over and above the Nifty.

Since Nifty contracts are available for a maximum of three months, you have to roll over the contract as and when it expires.

If the fund underperforms the index, you will end up a loser. Some sophisticated investors and hedge funds are actually doing this, explaining the sudden spurt in trading volumes.

Going by Morgan's record over the past few years, chances are that it will beat the market averages. Morgan has often trailed behind category averages but has beaten the benchmark fairly regularly.

Also, its portfolio is overweight on industrial stocks, which include capital goods, engineering, power and construction stocks. Morgan is also overweight on autos; neutral on banks; and underweight on infotech, metals and consumer staples.

Top sectoral allocations include cap goods, financial services and technology. Scrip-wise, the fund is spread across 40-odd stocks - largely stable large-caps with good earnings visibility and a few quality mid-caps.

The portfolio looks growth-oriented with the price-earnings hovering around 20x trailing earnings. The top five holdings are Bhel, ONGC, Infosys, HDFC Bank and Hero Honda.

Besides, there is scope for some marginal windfalls in future. For instance, portfolio holdings which carry a lock-in period (bought through a preferential offer) are valued at a 10 per cent discount to the market value. So in a year's time when these stocks are eligible to be sold in the markets, they will be revalued at market value.

Since the value of such holdings account for about 3 per cent of the NAV currently, an upside of 300 basis points or 3 per cent is waiting to happen.

Another interesting point to note here is that while you pay 16 per cent less for the fund, your portfolio is actually compounding at the full value.

In other words, even if you buy units at Rs 21.63, your gains will be on a base of Rs 26.03 (NAV) on which the portfolio is actually growing. This slight difference in compounding can make a tangible difference to your returns.

Any downsides? The obvious downside is the performance of equities themselves. If the stock markets are depressed when the fund becomes due for maturity, the gains may be less than expectations. Also, there is a possibility that the fund lags behind the index as it approaches maturity.

The reason is that the fund will have to liquidate its holdings and generate cash to meet redemptions as it approaches maturity. So high allocation to cash, especially if the market is on an upswing at that time, will mean that the fund will trail the index.

Given that the fund has a corpus of nearly Rs 1,500 crore, it will need to unwind its positions gradually to ensure that it does not depress prices because of its own selling.

With more than a decade of trading history, only 20-25 per cent of the current unitholders are original investors. The huge surge in trading interest in the fund in recent times indicates that investors are essentially buying units with a clear objective to encash the discount.

Such investors would like to exit the fund when it matures/goes open-ended, necessitating the need to generate cash out of the portfolio.

For many investors, Morgan Growth may not sound very inspiring, as the fund was launched with much fanfare but miserably failed to reinforce investors' faith in mutual funds when the Indian public knew less about funds, especially about closed-funds.

As the fund got listed at a 40 per cent discount to its face value, which is usually the case with closed-end funds, investors panicked.

It is actually the discount that is making Morgan a great buy today.