What is a Close-Ended Funds?
A close-ended fund also called “closed-end investment” and “closed-end mutual fund. It is a type of mutual fund that pools resources from investors through issuance of New Fund Offer (NFO). And the units are sold at a price based on Net Asset Value (NAV) of the mutual fund that is launching the NFO.
On the other hand, the close-ended fund is a kind of Mutual Fund which is a portfolio of pooled assets that raises a fixed amount of capital through an IPO (Initial Public Offer) and then lists shares on a stock exchange for trade.
A closed-end fund functions like an exchange-traded fund. Unlike in open-ended funds, investors can’t buy the units of a closed-ended fund after its NFO (New Fund Offer) period is over.
In the case of Close-ended Fund new investor is not allowed to enter, and existing investor can’t exit till the term of the scheme ends.
The fund houses list their schemes of close-ended on a stock exchange to provide a platform for investors to exit before the terms.
The close-ended funds are free from the worry of regular and instant redemption and their fund managers are not worried about the fund size.
The character of Close-Ended Funds is different from Open-Ended Funds.
How does a Close-Ended Fund Works?
As per the guideline of SEBI an asset management company launches New Fund Offer (NFO), an investor buys units of the fund at a specific price. A New Fund Offer can be open for a maximum of 30 days.
They can be traded at premiums or discounts to their NAVs and with maturity period typically ranges from 3 to 4 years.
Investors who want to exit the fund before maturity can trade their units on stock exchanges. Like any other public security, Close-Ended Funds units are traded on stock exchanges. The price of the units fluctuates according to the market situation.
Close-Ended Mutual Funds are best suited for investors who are looking at a long investment horizon due to lock-in period.
This lock-in period until maturity ensures that investors make adequate capital gains on their investment.
The performance of a close-ended mutual fund depends on the investment style and skills of the fund manager, an investor looking to invest in a close-ended mutual fund should be prepared to undertake these risks. Investors should also bear in mind that closed-end funds need lump sum investment which may not be suited for all investors.
An investor can invest directly or can contact the agents and distributors of mutual funds for necessary information and application forms. Investors must ensure that the distributor chooses by him is register under AMFI (the Association of Mutual Funds in India) and the distributor has a valid AMFI Registration Number (ARN).
The investor either by visiting the mutual fund’s branches or online through mutual fund website if investments through the direct plan. Forms can be deposited with mutual funds through the agents and distributors who provide such services.
It helps to maximize the returns from the close-ended mutual funds and the other side if the investment is done through a distributor, they are required to disclose all the commissions payable to them for the different mutual fund’s schemes.
Before investing, an investor should refer to the product labeling of the scheme.
Advantages of invest in Close-Ended Funds
- Stability: Close-ended funds are stable in terms of their asset valuation. Redemption of the fund is only allowed on the expiry of the maturity period. Fund managers need not worry about further redemption and changes in total assets of the fund, and it helps the Fund manager to make a steady asset base and devise the right investment strategy. They can invest in securities (equity or debt securities) and other financial assets as per the market situations.
- Flexibility: The investors can sell these units according to the real-time prices available during the trading day.
- New opportunities: Close-ended funds offer investors to invest in new strategies that the existing open-ended funds do not offer.
- Diversified Portfolio: These funds allow the fund manager to create a unique portfolio to earn good returns. Due to the extended lock-in period, the fund manager can explore undervalued equity and debt instruments which would otherwise not feature in the portfolio.
Disadvantages of invest in Close-Ended Funds
- High volatility: There are different levels of risks associated with each close-ended fund. Trading in such funds requires research and analysis before any investment. Shares of closed-end funds in secondary markets are often accompanied by high volatility in trading. Prices may swing in one day’s trading action from one high value to a low-value point.
- Leverage in trading: Use of leverage in trading close-ended funds can create undesired adverse effects on the fund. This is particularly challenging due to sensitivity to interest rates. There are also problems when trading in low volumes, often low-volume trades can make it harder for quick sell action.
- High price: More risks are carried with high share values; this problem is facilitated by high price volatility.
- A disadvantage with redemption: There is no redemption privileges, which often help to align prices with the net asset value.