What is a Dual-Purpose Fund?

A mutual fund pools money from multiple investors and invests that money across various securities. It facilitates well-diversified portfolios and professional management. Hence, it minimizes risk and offers better potential returns.

There exist equity mutual funds that majorly invest in common stock of various companies. Some mutual fund invest in fixed-income securities and provide investors with a regular source of income. The ‘dual-purpose fund’ is a mixture of both.

This article highlights what is a dual-purpose fund, how it works, and its benefits.

Dual-Purpose Fund

A dual-purpose fund is a closed-end fund that allows investors to choose a share class to invest in. A closed-end fund is a type of mutual fund which is open for subscription during the NFO period and can be redeemed only at maturity. The dual-purpose fund invests in common stock and preferred stock

These mutual funds cater to the needs of two different types of investors, i.e. risk lovers and risk-neutral. In other words, some investors look for capital growth, while some look for regular income. Investors looking for growth in the capital may invest in common stock, which may or may not offer dividends, yet have a higher potential for big gains. On the other hand, investors looking for regular income from stock investing may choose preferred stocks.

Though preferred stocks grow slowly in value, they pay regular dividends to the investors. The preferred shareholders of the fund get the dividend proportionate to the par value of the shares they hold. The return of common stockholders of the fund depends on the stock’s performance. By choosing the suitable share class, the dual-purpose fund attempts to serve both types of investors with a single investment option.

There were seven dual-purpose funds trading in 1967, namely American dual Vest, Gemini, Income and Capital, Leverage Fund, Hemisphere, Scudder duo-vest, and Putnam Duo-fund. Except for Putnam Duo-fund, all were traded on the New York Stock Exchange. Putnam Duo-fund was traded over the counter. However, other funds were having better tax advantages which made these funds unappealing.

How do dual-purpose funds work?

Investors can subscribe to dual-purpose funds through New Fund Offer. Investors can choose to invest in either equity or preferred stock. Once the new fund offer subscription period ends, the Net Asset Value (NAV) of the fund is determined based on the number of units and the total value of underlying assets. The dual-purpose fund is, then, traded on stock exchanges. Depending on the market prices of equity and preferred stock the fund holds, its price keeps fluctuating. Investors holding preference share units keep getting dividend and interest income between NFO and Maturity.

The fund comes with a fixed number of units and maturity. On the maturity date, the investors redeem the units to the fund and preferred shareholders are paid out first. Those investors are entitled to the face value of their shares. After paying out to preferred investors, the residual capital is distributed among equity shareholders.

Benefits of dual-purpose funds

• One investment option, two opportunities: A Dual-purpose fund is an investment option that brings two different investment opportunities for two different kinds of investors. Some investors aim at capital growth, while some wish to have a regular flow of income. A dual-purpose fund fulfils the wishes of both investors by investing the pooled money in common stock and preferred stock.
• Customized portfolio: A dual-purpose fund caters to the tailored-portfolio needs of investors. This fund gives the investors a choice of the share class that best suits their risk and return expectations. The risk-loving investors find an equity investment more appealing whereas the risk-neutral or risk-averse investors may look for an investment avenue that protects the capital and offers a steady flow of income. The investors can choose equity or preferred stock according to their investment objective.
• Liquidity: Although all close-ended funds seem illiquid at first, they are not. In closed-end funds, the investors can not redeem the units to the fund before maturity. However, these funds are traded on the stock exchanges. Investors can exit the fund by selling the units to other investors. Sometimes, investors may get an opportunity to sell the units at a higher price in the market.
• Professional management: The dual-purpose funds are managed by professional fund managers. As they have skills, knowledge, and experience in the market, they can make sound investment decisions. A wise investment decision brings higher potential returns for investors.

To wrap up, a dual-purpose fund is a closed-end fund that serves two objectives of two different types of investors. By investing in common stock and preferred stock, the dual-purpose fund provides investors with their preferred type of return from dividends and capital appreciation. Additionally, these funds are managed by professional fund managers and the return on investment greatly depends on their skills. Due to tax disadvantages, dual-purpose funds have lost their spark.

Frequently Asked Questions

What is the difference between dual-purpose funds vs STRIPS ?

Ans. STRIPS stands for Separate Trading of Registered Interest and Principal Securities. STRIPS allows investors to keep and trade interest and principal components of a bond separately. In dual-purpose funds, preferred shareholders take the dividend income portion whereas capital growth is accessible for equity shareholders.