What are Close-ended Mutual Funds and How Do They Work?

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Synopsis:

Close ended mutual funds are one of the three types of mutual funds categorised by scheme structure. The units of a closed end fund can be purchased only during a New Fund Offer and, subsequently, through the stock exchange where the fund is listed. A close ended mutual fund has a fixed lock-in period during which the fund's units can only be redeemed via a sale in the market or a buy back from the issuing fund house.

In the twenty-first century, mutual funds are counted amongst the most popular market-linked investment vehicles. You can start your mutual fund investment with a small amount and choose from a variety of funds available in the securities market. When categorised by scheme structure, there are three types of mutual funds, one of which is close ended mutual funds. 

In this article, we shall delve into 

  • Meaning of closed end funds and how they work 
  • Major benefits of close ended mutual funds 
  • Key drawbacks of close ended mutual funds 
  • Steps to invest in a closed end fund 

Close Ended Mutual Funds: Definition and Functioning

A close ended mutual fund is a type of mutual fund which has a limited access for subscription and redemption. The units of close ended mutual funds are offered to the public through a New Fund Offer (NFO) and once the units have been allotted to the applicants, there is no further issuance of the fund's units. 

After the allotment of fund units through an NFO, a closed end fund gets listed on a stock exchange, and its units can be purchased and sold in the open market just like any other security. The market price of the fund's units gets determined by the forces of demand and supply, and can be either above or below the actual Net Asset Value (NAV) of the fund. 

A striking feature of close ended mutual funds is that their units can be redeemed through the issuing fund house only at the expiration of the fund's tenure. However, the fund house can offer the subscribers a buy back option on a periodic basis. The open trading of the fund's units on a stock exchange is, therefore, the easiest and most convenient mode of premature withdrawal for investors. 

Akin to any type of mutual fund, close ended mutual funds are managed by dedicated fund managers. Such a fund can invest in a variety of asset classes, including equity and debt. Since there is no requirement to keep a certain proportion of the fund's corpus liquid for redemption requests, the fund manager of a closed end fund is well placed to invest the funds as per the investment objective decided for the fund. 

Advantages of Close Ended Mutual Funds

Close ended mutual funds carry a host of benefits, prominent amongst those being:

  • Potential for long term gains: Close ended funds are effective vehicles for long term investment and potential capital appreciation. Investors looking to park their funds for a substantial time period without having to constantly worry about redemption can find such funds ideal for their portfolio. 
  • High degree of stability for the fund manager: One of the key benefits of closed end funds is that the relevant fund manager has a relatively fixed total asset base to allocate. There is usually no sudden withdrawal of the fund's units unless initiated by the fund house as a buy back offer. The stability of the assets under management can potentially enable the fund's manager to allocate the fund in an effective and profitable manner. 

Disadvantages of Close Ended Mutual Funds

There are some disadvantages of closed end funds which you must consider before investing in such funds. 

  • No option for SIPs: The most striking bottleneck of a close ended mutual fund is that there is no option to invest in phases. You can only invest in such a fund through a lump sum investment. 
  • Excessive reliance on fund managers: Since there is no redemption pressure on the fund manager of a close ended mutual fund, they can effectively allocate the fund units based on their knowledge and expertise. Hence the fund's performance is largely contingent upon the intellect and the decision-making prowess of the fund manager. 

How to Invest in Close Ended Mutual Funds

Should you decide to invest in a close ended mutual fund, you can do so by following either of the below-mentioned modes of investment. 

  • Through the Asset Management Company: You can invest in a close ended mutual fund through the official website of the issuing AMC, and save the hassle of the time and cost of involving an intermediary. 
  • Through a mutual fund distributor: Another way to invest in a closed end mutual fund is to utilise the services of an authorised mutual fund distributor or agent. Opting for this mode of investing in a close ended fund shall attract some fee and your overall investment cost shall be higher than in the direct mode of investment. 

Conclusion

Akin to any investment avenue, close ended mutual funds have their fair share of pros and cons. Before investing in any closed end fund, you must meticulously peruse the scheme documents to understand the scheme structure, intended asset allocation, redemption, etc. 

Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.

This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.

For All Disclaimers Click Here: https://bit.ly/3Tcsfuc

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