- What are Closed Ended Funds?
- How do Closed-Ended Funds work?
- Advantages of Investing in a Closed Ended Fund
- Limitations of Investing in a Closed Ended Scheme
- Who should Invest in a Closed-Ended Schemes?
- What are Open-Ended Funds?
- What is the Difference Between Open-Ended Funds and Closed-Ended Funds?
- Frequently Asked Questions
Closed-ended funds are mutual funds that have a fixed lock-in period and maturity. Unlike open-ended funds, the units of these funds trade on the stock exchanges just like shares. Though the value of the fund is derived through NAV, the real price of the closed-ended funds is based on the demand and supply factors. This article covers closed-ended funds, their advantages, disadvantages and how they differ from open-ended funds in detail.
What are Closed Ended Funds?
As the name suggests, a closed ended mutual fund is a fund where investors cannot enter or exit from the fund until the term of the fund ends. However, there will be a platform for investors to exit the fund before the term ends as these funds are listed on stock exchanges.
The fund issues only a fixed number of units during its launch. It is open for subscription only for a certain time. Thereafter, if anyone wants to invest in this fund, they can buy it from the stock market where the fund will be listed. Investors can invest only in a lump sum and cannot choose the SIP route for these funds.
Also, investors who subscribed to this fund during the NFO can sell their units on the stock exchange. Moreover, some closed-ended funds buy back the units from investors at NAV in order to provide an exit route to them. As per SEBI regulations, fund houses must provide one of these two exit routes to investors.
Closed-ended funds come with a fixed tenure of around 5-7 years. However, investors who choose to exit from the fund can do so by selling their units on the stock exchange. The number of outstanding units of a closed-ended fund does not change even though they trade on the stock exchange.
The fund managers of these funds neither worry about the regular and sudden redemptions nor the fund size. Hence this allows the fund managers to experiment and practice freedom in investment choices to fulfil the fund’s objectives.
How do Closed-Ended Funds work?
A closed-ended fund is launched like any mutual fund through a New Fund Offering (NFO). Investors subscribe to this fund by way of application during the stipulated time. After the NFO closes, the fund house lists the fund on the stock exchange.
Now the fund is available for buying and selling units through the stock exchange. However, the number of outstanding units will remain the same. Moreover, the fund house can also repurchase the units from existing investors periodically at the NAV. The value of the closed-ended fund is based on NAV. However, the actual price depends on the demand and supply for the fund. Hence these funds can trade at a premium or discount to NAV. The NAV of these funds is disclosed on a weekly basis.
Investors can stay invested in the fund until its maturity, which is usually around 5-7 years. The details of the same will be given during the launch of the fund.
Advantages of Investing in a Closed Ended Fund
Following are the advantages of investing in a closed-ended fund:
- Stable Asset Structure: Redemption of units for these funds can be done only on predetermined dates, i.e., when the fund matures. This provides portfolio managers with a consistent asset base that is not vulnerable to frequent redemptions. In other words, they need not worry about the frequent cash inflows and outflows. With this, the fund manager will be able to formulate a more comfortable investment strategy.
- Trade on the Stock Exchange: Like equity shares, these funds also trade on the stock exchanges. Hence investors can buy and sell the units in real-time. The market prices can be above or below the fund‘s NAV. Furthermore, they can leverage the stock trading strategies like market or limit orders and margin trading.
- Flexibility and Liquidity: Redemptions are not allowed for these funds. However, it gives the investor the flexibility to sell their units with being listed on the stock market. Therefore, one can easily liquidate their investment. Buying and selling take place at prevailing market prices available during the trading day.
- Lower Operating Costs: Closed-end funds have lower marketing costs and turnover rates. As a result, they have lower operating and management costs.
Limitations of Investing in a Closed Ended Scheme
Following are the limitations of investing in a closed-ended fund:
- No Track Record: Unlike open-ended schemes, investors cannot review the historical performance of closed ended schemes over different market cycles. As there is no historical data available. Therefore, the fund manager’s experience and expertise play a major role while selecting a fund.
- Only Lump Sum Investments: Closed-ended schemes accept investments only during the NFO. Once the NFO closes, new investments cannot be made to the fund. As a result, only lump sum investments can be made. Investors who wish to do SIPs cannot invest in these funds due to this reason.
- Lower Performance: Historically, closed-ended schemes have not performed as well as their open-ended counterparts. The lock-in period on closed-ended funds, which is supposed to provide fund managers more flexibility in allocating money without fear of withdrawals, hasn’t helped improve returns.
Who should Invest in a Closed-Ended Schemes?
Closed-ended funds suit investors who want to invest for a fixed tenure. These funds have a lock-in period, though the units sell in the stock market, and investors who are comfortable with this can consider investing in them.
These funds may not offer adequate capital gains as they have a fixed tenure. Investors who want to invest and sit tight can invest in these funds. Also, these funds do not offer SIP. Investors can invest in them only through lumpsum. Hence investors who are comfortable investing a huge amount of money can choose these funds for investment.
What are Open-Ended Funds?
Open-ended mutual funds are regular mutual funds. Their units do not trade on the stock exchange. They do not have a fixed number of units or a fixed maturity period. Open-ended funds are launched through NFO, and the NFO is open for a maximum of 30 days. Once the NFO closes, the investors can still invest in the fund through SIP and lump sum investments.
Open-ended funds are very liquid and offer the flexibility to redeem anytime. Investors can invest in them anytime during the fund‘s existence. Moreover, investors can redeem their units by directly selling them to the fund house at the current NAV. The NAV of the fund depends on the performance of the underlying securities and not on the demand and supply. Also, the NAV is disclosed at the end of every day by the fund houses.
Also, open-ended funds have a track record where investors can analyse the fund‘s past performance. Since they do not have a fixed maturity period, they are considered to have perpetual existence. These funds suit investors who do not want to continuously monitor their investments on a regular basis but are looking for good returns.
What is the Difference Between Open-Ended Funds and Closed-Ended Funds?
Following are the differences between open-ended and closed-ended funds: Open Ended vs Closed Ended Funds
|Parameter||Open-Ended Fund||Closed-Ended Fund|
|Liquidity||Highly Liquid, buying and selling of fund units can be done any time. Except for ELSS funds, as they have a three year lock-in period.||Redemptions are not allowed during the lock-in period. However, buying and selling can take place on the stock exchange.|
|Track Record||Before investing, one can check the track record of the scheme over different market cycles.||Closed-ended funds can be bought only during NFO, and hence there is no track record available.|
|Types of Investments||Both lump sum and SIP||Only lumpsum, No SIPs.|
|Asset Base||Stable Asset Base||No Stable Asset base|
|Investment Amount||The minimum investment amount can be low as INR 500 to INR 1,000||Often, INR 5,000 is the minimum investment amount for closed-ended fund NFO.|
Frequently Asked Questions
Closed-ended mutual funds are taxed like open-ended mutual funds. For equity funds, the short term capital gains are taxable at 15%, and long term capital gains above INR 1 lakh are taxable at 10%.
For debt funds, short term capital gains are taxable as per the income tax slab rate of the investor. At the same time, the long term capital gains are taxable at 20% with indexation benefit.
Closed-ended funds charge an expense ratio like any other mutual fund. The expense ratio ranges between 0.25% to 2% and sometimes even higher. In case of closed-ended funds with borrowings, the expense ratio is charged on the net assets along with borrowed assets. While in the case of closed-ended funds without borrowings, the expense ratio is charged only on net assets.
Closed-ended funds can be considered for investment and can be a part of an investor’s portfolio. Since the fund managers have greater flexibility in terms of operating the fund, the fund has greater potential to deliver good returns. Moreover, fund managers can borrow funds to enhance returns of closed-ended funds. Since the funds trade on the stock exchange, investors can liquidate their units when the fund is not performing as per their expectations.