WHAT'S ON OFFER

FUND: Kotak Twin Advantage Series III MATURITY: Close-ended fund maturing in August 2009 INVESTMENT PATTERN: 65-100 per cent in debt and money market 0-35 per cent in index call options LIQUIDITY: Withdrawals allowed every 25th day of March, June, September and December MINIMUM INVESTMENT: Rs 5,000 EXIT LOAD: No exit load but exiting unitholders will be charged balance unammortised expenses OPEN: Till August 25

The Twin Advantage Series III fund from Kotak Mutual Fund attempts to do just that. It is a close-ended hybrid fund that will invest at least 65 per cent of its corpus in the debt and cash market and up to 35 per cent in index call options. These call options allow an investor to take a bet on the future level of the index by paying a small premium. If the index rises, the investor (or fund) makes a handsome profit. However, if the markets come down, the investor loses the amount he paid as premium. There is no cap on the upside while the downside is limited to the premium paid.

For instance, on August 16, when the Nifty was around 3,360, the Nifty call option of 3,400 strike rate for August was available for about Rs 48. This Rs 48 is the premium an investor would pay for the position. If the markets rose, the premium on the contract would go up. One can either sell and book profits or hold on till the expiry of the contract on August 31. If by then, the Nifty crosses 3,448 (strike rate plus the premium) the investment would be profitable.

Just like calls are bullish on the markets, put options are bearish. But the Twin Advantage Fund will only invest in calls. It will also not invest in the potentially more profitable (and potentially riskier) stock options. "Exposure to an individual stock is riskier compared to a basket of stocks. Moreover, index options have maximum liquidity and tend to mirror the entire market," says Sandesh Kirkire, CEO, Kotak Mutual Fund.

If the market has been correctly sized up by the fund manager, options could be hugely profitable. Says Dhirendra Kumar, CEO of mutual fund tracker ValueResearch, "The 25-30 per cent of the corpus invested in index options has the potential to earn like 80 per cent."

Kotak Mutual Fund has done extensive research to test the feasibility. Its analysts made 155 hypothetical investments over the past 16 years to calculate the returns. The results were a positive 111 times.

The fund seeks to preserve the invested capital through the portion invested in debt. Going by the current bond yield, Rs 65-70 invested in the debt market would grow to about Rs 100 when the fund matures.

The safety aspect is borne out by the performance of the Kotak Twin Advantage Series II fund. Launched in May this year, when the "irrational exuberance" was at its peak, the fund has managed to stay in the green even as other categories of funds with an exposure in equities have suffered losses (see table). But Kirkire says investors should not look at short-term performance. "To realise the full potential of the fund, investors should wait out till the maturity period," he says.

Close-ended funds are one way of forcing investors to take a long-term view. They also allow fund managers greater flexibility which translates into fatter returns for investors. Tax saving funds often outperform diversified equity funds precisely because they have a three-year lock-in period. For instance, the best performing tax saving fund, Magnum Taxgain, has given an annualised return of 85.32 per cent in the past three years, overtaking the 79.37 per cent returns given by the best diversified fund Magnum Global. Clearly, it pays to have a long-term perspective.

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