Investment was an aspect that was always at the top of Ashima’s mind, especially since she was keen on bootstrapping her startup in the next ten years. When she started researching on potential avenues for investment, she came across the term close-ended funds and began wondering what this meant. Mutual funds can be of many varieties from balanced advantage funds and equity funds to debt funds and hybrid funds. Depending on their underlying strategy and scheme structure, these funds can be classified as close ended funds, interval funds or open ended mutual funds.

What are close ended funds?

The above-mentioned classification is based on the frequency with which investors like Ashima can buy or sell units of the scheme. As the name suggests, close ended funds, which have started to gain traction in recent times, comprise equity or debt funds which issue only a fixed number of units at the time of their launch, also known as the New Fund Offer (NFO) period. When this pre-decided time ends, investors are not allowed to buy or redeem units of the fund. Following their closure and allotment of units, close ended funds can be traded on the exchange in the market, akin to equities. These schemes have a fixed maturity period, at the end of which, investors have the ability to redeem their units. In the meantime, these units are traded in line with the demand-supply equation, with the net asset value or NAV of the scheme indicating the actual price of the units you hold. Close-ended funds, therefore, close for investment and redemption as soon as the NFO ends, offering your fund manager greater flexibility while fulfilling the underlying investment objectives of the scheme.

Advantages of close ended mutual funds

Now that you know that close ended funds do not offer you the flexibility to purchase new units, or redeem the units allotted to you post NFO closure, you may wonder about the advantages of investing in such a scheme. Following are some of the major benefits which are prompting investors to consider close ended funds –

Flexibility for fund managers: Given that close-ended funds do not allow investors to redeem their investments prior to the maturity date, such schemes offer fund managers a fixed asset base to manage. Due to the lack of potential redemptions, fund managers need not worry about maintaining liquidity and cash components within the corpus. Accordingly, they have the freedom to put your money to good use and follow the pre-ascertained strategy to the T, thereby offering potentially better returns and enabling better achievement of the scheme’s investment objectives.

Possibility of higher prices: While you cannot redeem your units, you can sell them on the stock exchanges, just the way you trade equity funds. In the market, the prices of these units are determined by the demand and supply equation and, when a particular closed ended scheme’s units enjoy greater demand, amid the limited supply, it is possible for investors to sell their units at prices which may be much higher than the one determined by the NAV of the scheme.

Liquid nature of schemes: While many investors think that close-ended funds are illiquid since they cannot redeem them prior to the maturity date, this is not completely true. Investors like Ashima have the option of selling or purchasing new units on the stock exchange wherein the fund is listed, ensuring liquidity in line with equity stocks.

Disadvantages of close ended mutual funds

So, what are some of the disadvantages that Ashima and other potential investors should consider when thinking of investing in close-ended funds?

Historical performance: While such schemes are beginning to gain traction, they have not offered a very rosy picture if we consider historical performance, despite the absolute freedom enjoyed by fund managers. Further, the returns offered by such schemes have not been greater than the ones offered by open-ended schemes, making investors slightly wary of committing to these funds.

Inability to invest via SIPs: Investors can only buy units in close-ended funds during the NFO period or on the stock exchange, and both of these routes necessitate a lumpsum investment. Many investors are keen on systematic investment plans due to the low risk posed by staggered investments. SIPs also allow you to enjoy the benefits of compounding and rupee cost averaging, which cannot be availed while investing in close-ended funds.

Absolute dependence on fund managers: Considering the significant freedom enjoyed by fund managers who handle close-ended funds, many investors tend to be cautious of such schemes. Usually, investors prefer to analyse the historical performance of interesting schemes, before investing in the same but close-ended funds do not offer this opportunity.

Now that you know all about close-ended funds, it is up to you to decide whether they make an optimal investment option basis your requirements.

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