What Are Close Ended Mutual Funds?
When planning on a holiday, you generally have two options — plan your own itinerary and keep making changes on the go or sign up with a travel agent and follow his itinerary, wherein you cannot make any changes. A similar concept applies to mutual funds, particularly when deciding between open ended funds — where you can buy and sell units anytime — or close ended mutual funds — where you cannot buy and sell units during the tenure of the scheme. Read on for more.
What is a Closed-End Fund?
A close ended mutual fund is defined as one which has a stipulated maturity period. You can subscribe for close ended schemes during a specified period at the time of launch of the scheme and the units can be redeemed only when the lock-in period of the scheme is over. Hence, during this period, there will be neither outflows nor new money coming into the fund.
However, units of close ended mutual funds can be traded on the stock market. The net asset value determines the underlying value of the fund. But because the units of these
mutual funds are tradable, that value can fluctuate depending on demand and supply. Thus, close ended funds can be available either at a discount or premium to the net asset value.
Advantages of Closed-End Funds
Stable assets:
Since there’s no pressure on capital flows, fund managers can be freer to manage closed-ended funds. They have better visibility of the corpus they are required to oversee and can make decisions from a long-term perspective.
Secondary market:
Since they are traded on the stock exchanges, units of close ended funds can be bought or sold on the secondary market providing liquidity.
Lesser operating costs:
Closed-ended funds have lower turnover rates (the percentage of the mutual fund’s holdings that changed over the past year), which translates into lower operating and management costs.
Disadvantages of Closed-Ended Funds
Lesser flexibility:
Close ended funds can only be redeemed at maturity. Hence, if you prefer a fair amount of flexibility regarding the capital at your disposal, these funds might not work for you.
Lumpsum:
Investments in close-ended schemes require you to put in a lumpsum amount while purchasing units, be it in the primary or the secondary market. They don’t allow for a staggered investing approach which is the cornerstone of
Systematic Investment Plans (SIPs).
No track record:
Investors cannot review the historical performance of close-ended schemes over different market cycles because of the absence of historical data. Therefore, the fund manager’s expertise plays a major role while selecting a fund.
How to invest in Close Ended Funds?
The first and foremost way to invest in close ended funds is through the initial
new fund offer. But if you have missed that boat, you have the option of purchasing units of these funds from the stock market. When close ended schemes trade at discounts to the new asset value, investors can consider it a suitable buying opportunity.
To conclude
While open ended funds generally tend to be the preferred choice, you need not completely shut the door on close ended funds. If you have an investible amount, an investment objective that aligns with your risk appetite and goals, and a horizon in line with the maturity date of the scheme, close ended funds can be worth considering.
FAQs
How are closed ended funds different from open ended funds?
Open ended funds are highly liquid because fund units can be bought or sold anytime. In a close ended fund, units can be redeemed only at maturity. However, you can buy or sell these units on the stock exchanges, unlike open ended funds. Further, close ended funds only provide the option of lumpsum investments, while in open ended schemes, investors can choose either a lumpsum or SIP route.
How does capital gain taxable in the hands of investor in the case of a close ended mutual fund?
The capital gain is taxable in the hands of investor as per classification of Equity and Other than Equity Oriented fund. Tax on capital gain is different in case of Other than equity oriented fund or equity oriented fund . Generally fund is classified as equity oriented fund if a minimum of sixty-five per cent of the total proceeds of such fund is invested in the equity shares of domestic companies listed on a recognized stock exchange otherwise it will treated as other than equity oriented fund.
