A mutual fund is a great investment option for individuals who want to diversify their investments. A mutual fund can be categorised according to its structure into three types, including open-ended, closed-ended, and interval mutual funds. The open-ended and close-ended mutual funds have gained more traction than the interval funds.
While an open-ended fund is more popular among investors, there are some restrictions on a closed-ended fund. This blog provides a guide on close-ended mutual funds, how they work, and their advantages and disadvantages. You can also find and invest in this category of mutual funds through this blog.
Close-ended Fund Meaning
A closed-ended fund is a debt or equity mutual fund in which the fund houses issue a predetermined number of units at the time of a new fund offer (NFO). Existing investors cannot redeem their invested capital before the end of the maturity period, while new investors are not allowed to do so after the end of the NFO period.
Closed-ended funds are launched through the NFO and then listed in the stock market for trading. The net asset value is determined by the actual value of the fund. Hence, the trading price can fluctuate above the NAV or below according to supply and demand dynamics in the stock market.
What is the Process of Closed-Ended Funds?
Investors purchase units of a close-ended mutual fund at a certain price set by the asset management company (AMC) during the NFO period. Investors cannot enter the particular scheme after the NFO period ends. The investors also cannot exit the closed-ended fund scheme before its maturity.
The money will be transferred to the investor after the scheme dissolves. The investor will receive the money at the prevailing NAV on that specific date. If anyone wants to exit a closed-ended fund scheme before its maturity period, they can sell the units on the stock market.
The scheme will start an NFO for that closed-end mutual fund to raise money. They will receive units in return for making monetary contributions to the mutual fund scheme. Then, the units are listed on the secondary market, where investors can trade them as per the supply and demand.
A closed-end mutual fund does not issue new units or repurchase existing ones. Units of these funds are issued only once. The only way to get into this fund later is for the investors to purchase units on the open market.
Advantages of Closed-Ended Funds
A closed-ended fund locks your investments for a particular period but offers numerous benefits. Below is the list of advantages that you must know before investing in closed-ended mutual funds:
- High Stability: Since investors cannot redeem the units before the maturity date, the fund manager’s job becomes easier. They do not have to maintain the fund’s liquidity or worry about sudden outflows. Therefore, fund managers can create a strategy with a long-term aim to achieve the investment objectives of these schemes.
- Ease of Access: These funds are easily accessible for investors as they are traded on the stock exchange. Investors can buy and sell them directly from the stock exchange, allowing for an early exit.
- Long-term Investments: Closed-ended mutual funds have a maturity period which prevents investors from redeeming them before the timeframe. This ensures higher returns for investors, which makes them more financially stable and better for the long term.
- Dynamic Market Price: Since their prices are determined by the market’s supply and demand, a close-ended fund can be traded in a stock exchange. A high demand and a low supply can move the selling price of the units above the scheme’s NAV.
- Avoids Illiquidity: Although they do not allow early unit redemptions, there are many chances to acquire and sell these funds from the stock exchange. This ensures high liquidity for investors. Investors can purchase or sell the units of these funds at the market rate.
Disadvantages of Closed-Ended Funds
Besides the advantages, there are also several disadvantages of investing in closed-ended mutual funds. The below list highlights the disadvantages of closed-ended funds:
- No Option for SIP: You cannot invest in this category of mutual fund with a systematic investment plan (SIP). Lumpsum investment is the only option for you to invest in closed-ended funds. This can increase your risks since you cannot spread your investments through an SIP.
- Dependency on Fund Managers: Investors tend to evaluate the performance of a particular mutual fund scheme over different market cycles before investing in it. However,closed-ended funds do not have any prior data that investors can study. The performance of these funds is highly dependent on the fund managers.
- Poor Past Performance: The fund managers of these funds are in a great position to incorporate new investment techniques for achieving various investment objectives. However, they can still give poor returns compared to open-ended funds, where all details are fully disclosed.
What are the Differences Between Closed-Ended and Open-Ended Mutual Funds?
Understanding the differences between closed-ended and open-ended funds is crucial, as it affects your decision-making regarding buying and selling units and tracking price fluctuations. The below table highlights the key differences between closed-ended and open-ended mutual funds:
| Factors | Closed-Ended Mutual Fund | Open-Ended Mutual Fund |
|---|---|---|
| Liquidity | This fund lacks liquidity and options for redemption until the end of the lock-in period. | An open-ended mutual fund provides high liquidity except for Equity-Linked Savings Schemes (ELSS) funds, which have a three-year lock-in period. |
| Track Record | Closed-ended funds do not have any past record since they are open for investment once. | Investors can track the record of open-ended funds by reviewing their historical performance. |
| Ways of Investment | You can invest in closed-ended funds only in the NFO period through lumpsum investing. | You can take advantage of the flexibility of both lump sum and SIP investment modes and make multiple purchases. |
| Minimum Investment | For investing in a closed-ended mutual fund, you have to make a minimum investment of ₹5000. | You can invest a minimum of ₹500 and ₹1000. These funds are available for a broad range of people. |
| Risk Tolerance | The lock-in period in these funds allows investors with higher risk tolerance to have more stability when making investment decisions. | The liquidity in these funds allows investors to react to market developments. This is beneficial for risk-averse investors to protect their investments in bearish markets. |
| Rupee-Cost Averaging | Investors cannot get the benefits of rupee-cost averaging as there is no option to make investments after NFO. | Investors can benefit from rupee-cost averaging through SIPs. These help investors reduce their investment costs. |
Who Can Invest in Closed-Ended Funds?
Investors looking for long-term investments with a lumpsum amount can consider investing in close-ended funds. These mutual fund schemes do not offer a redemption option till maturity. The risks and returns can be evaluated based on the scheme’s asset allocation as outlined in the offer document.
What are the Tax Implications of Closed-Ended Funds?
Taxation becomes a crucial aspect when it comes to investing in any securities. If a fund makes 65% of its investment in equities, 20% short-term capital gains are applicable if units are sold in one year. In addition, 12.5% long-term capital gains will be applicable for holding units for more than one year.
For non-equity funds, all capital gains are added to the investor’s taxable income and taxed as per the income tax slab rate, regardless of the holding period.
What are the Different Ways to Invest in Closed-Ended Funds?
Since you know what close-ended funds are, you can start investing in them. Here are some common ways you can follow to invest in closed-ended funds:
- You can invest in closed-ended mutual funds with the assistance of distributors. On the other hand, you can receive a larger number of units when you choose a direct plan. You do not have to pay any commission to the distributor for this.
- Take the help of AMCs to buy NAVs of a closed-mutual fund directly.
- Furthermore, you can also invest in these funds online with the websites of a particular mutual fund company.
- Using an online broker can also help you to invest in a closed-ended mutual fund. Open a demat account with the Torus Digital platform for free, which will take only six minutes. Then, navigate to the NFO section and select the mutual fund that is best for you. Finally, select a suitable amount which you want to invest.
How to Choose the Best Closed-Ended Fund?
A closed-ended fund offers a lot of features like liquidity and high stability. However, choosing the best closed-ended fund can be difficult. Consider following these steps to invest in the best closed-ended funds:
- Like every mutual fund scheme, you must do comprehensive historical research and profile of fund managers.
- Ensure you choose closed-ended funds that are in line with your investment goals.
- Go through every detail related to the lock-in period and the maturity period.
Final Thoughts
For closed-ended funds, investors must purchase units of mutual funds by paying a certain price through an NFO. This category of mutual funds does not allow investors to buy the units after the end of the NFO period.
Don’t have a demat account? Download the Torus Digital application to open a Demat account without paying any charges. Torus Digital offers you a convenient platform to invest in closed-ended funds.
