Close Ended Funds

Investors have plenty of choices when it comes to mutual funds and it’s not difficult to find one that meets their investment goals and the risk they are prepared to accept. Mutual funds come in two forms: Open-ended funds and close-ended funds.

An open-ended mutual fund is one that is always open for investment and never closed. Hence investors can invest whenever they want, and exit whenever they choose. Most mutual funds are open-ended. When new investors make large purchases, fund managers of open-ended funds purchase more shares from the stock market. When investors redeem mutual funds, the fund managers sell some of the assets under management to pay for the redemptions.

A close-ended mutual fund, unlike an open-ended fund, raises a fixed amount from the public through an initial public offering (IPO) in exchange for shares. The shares are then traded on the stock exchange.

The interesting thing about a close-ended mutual fund is that its price is not determined according to net asset value (NAV) but by demand and supply. So shares of a close-ended mutual fund could end up trading at a discount or at a premium to its NAV. This difference could be for various reasons. Like for example, if the fund manager has an exemplary record in earning high returns for investors, the close-ended fund may trade at a premium. If on the other hand, if investors have a poor perception of the fund, it will trade at a discount.

Unlike open-ended funds, whose NAV is declared at the end of each business day, prices of close-ended funds are dynamic and change by the second. Since it is traded on an exchange, a close-ended mutual fund is much more liquid than its open-ended counterparts.

However, you must also remember that you have to pay brokerage charges when you trade in a close-ended mutual fund. An open-ended fund, on the other hand, involves no such charges and units can be bought directly from the asset management company.

Benefits of close-ended funds

• Enables wider participation: A close-ended mutual fund enables wider participation in the stock market by making it easier for small investors. You need only small sums to invest and get exposure to a much more diversified portfolio.

• High liquidity: Since close-ended funds are traded on an exchange, it’s very easy to buy and sell units of a close-ended fund. You can redeem units whenever you need cash, and you can get the amount in under three days (trading day plus two working days).

• Easy to invest: Investing in a close-ended fund is very easy once you have done the KYC (know your customer) formalities. You can do it online as well.

• Transparent: Since a close-ended fund is listed on the stock exchange, pricing is transparent and depends on demand and supply.

• No redemptions: Since close-ended funds have a fixed tenure, fund managers don’t have to worry about large-scale redemptions in a bear market. Hence they may be able to offer better returns to investors.

Disadvantages of close-ended funds

• Volatility: Prices of close-ended funds can be volatile. If investor perception of the close-ended mutual fund is poor, prices will drop. Since trading volumes are low for close-ended funds, the volatility is exaggerated, and prices fall can be precipitous.

• Not ideal for small investors: Since close-ended funds are more complex and volatile, they need constant monitoring, so may not be suitable for small investors taking an invest-and-forget-it approach.

• Higher price risk: Since close-ended funds mature on a certain date, there’s no guarantee that prices will be favourable at that time. So you may not get what you expect.

• Leverage: Many close-ended funds use leverage, that is borrowed to buy securities so that they can have a larger corpus to play with and thus make more returns. This can lead to increased yields in a bull market but could magnify losses if prices are not favourable.

• Lump sum investment: Close-ended mutual funds do not have systematic investment plans or SIPs, so you will have to make lump sum investments. Many retail investors find it difficult to make such large investments. Lump sum investments also involve more risk since an investor can end up buying when the prices are high and suffer a loss when a correction occurs.

How to invest in a close-ended mutual fund

Once you have understood what a close-ended fund is, it’s time to invest. There are several ways of buying a close-ended mutual fund – online or offline. You can also buy it on the secondary market, once the close-ended fund is listed on the exchange. Here are the steps you need to take:

• Get your KYC done: Get a KYC form from us, fill the form, provide a passport-size photograph and proofs of identity and residence. You will need copies of your PAN card, passport or Aadhaar card. You can also do it online by uploading photographs and documents.

• Select the scheme: After doing the KYC, select the scheme you want to buy. You can do a comparison of the performance of various close-ended mutual fund schemes on the Angel BEE mutual fund app.

• Fill the mutual fund form: After that, you will need to fill the mutual fund form and hand it over to us along with the cheque for the amount. A distributor may offer you many more choices than a mutual fund company.

• Buying online: The most convenient way to buy a close-ended mutual fund is online – it’s quick and easy. Download the Angel Bee mutual fund app if you want to do it on your mobile phone.