What are Close-Ended Mutual Funds?
A mutual fund (MF) is an investment product, which pools the money of many small investors, and invests it in assets like equity, debt, and gold. There are many technical terms related to mutual funds that investors should know about.
A close-ended MF is a scheme in which investors may only subscribe to during the New Fund Offer (NFO) period. An NFO is when a mutual fund scheme is launched by a fund house. Such an offer is launched with the aim of raising funds from investors that may be invested in different assets. Interested investors may submit applications to subscribe to units of the new fund at the offer price.
A mutual fund NFO is similar to an Initial Public Offer (IPO), wherein shares of a company are offered to the public investors for the very first time. After the end of the NFO, new investors are unable to enter the scheme and existing investors are not allowed to redeem their allotted units. The main difference between a close-ended and open-ended mutual fund scheme is that you can buy or redeem your units at any time in an open ended scheme.
How Do Close-ended Mutual Funds Work?
A close-ended scheme has a specified tenure and a fixed maturity date. At the end of the tenure, which can be three, five or ten years long, the scheme is dissolved and the money is returned to the investors. Alternatively, the scheme may be converted to an open-ended plan.
Investors may want to know what a close-ended mutual fund’s advantage is. A close-ended fund lets the fund manager manage the corpus more efficiently because the funds raised by the scheme are locked-in during the tenure. This allows the fund manager to create a suitable long-term investment strategy for the scheme. It relieves the pressure of delivering returns amid short-term pressures. Fund managers may analyze different assets and select those that have the best growth potential. Some of these assets may not offer much liquidity in the short-term but may have the potential to deliver excellent returns when held over a longer term.
How To Sell Close-ended Mutual Funds?
However, in order to give investors a platform to enter and exit the MF scheme, the same is listed on the stock exchange. Here, units of the scheme are freely traded between investors. A stockbroker acts as an intermediary to the process of buying and selling of units. The units may be traded at a premium or discount to the NAV depending on market forces. Unlike open-ended mutual funds, the number of close-ended mutual funds units traded on the market remains the same throughout the tenure.
What Are The Advantages And Disadvantages Of A Close-ended Mutual Fund?
1. More Liquidity Than FDs
A close ended fund allows you to trade your mutual fund units on the share market unlike FDs which you have to break after going to the bank. You can also sell a small number of units whereas you have to break the entire FD if you don’t want it.
2. No Provision For Systematic Investment Plans
Small investors have shown a preference for staggered but regular investment in mutual funds through Systematic Investment Plans (SIPs), which may be for as less as INR 500. In case of close-ended MFs though, this option is not available to investors as a lump sum amount is required at the time of subscription. Investors run the risk of putting all or most of their money in the fund at a time when the market is expensive and may be forced to exit when the market falls. Alternatively, they would have to wait until the notional losses are recovered before selling their units.
Close-ended funds have pros and cons like every other investment product. Every investment portfolio is different because the risk profile, age, and financial goals of every investor are different. Creating and managing a healthy portfolio may seem challenging but with the right guidance, investors may master the art of investing.
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