Closed ended mutual funds are mutual funds with a fixed lock-in and maturity period. In contrast to open-ended funds, the units of these funds are traded on stock exchanges similarly to shares. Although the fund’s value is determined by Net Asset Value (NAV), the actual price of closed-end funds is determined by demand and supply.
What Are Closed-Ended Funds?
As its name implies, a closed-ended mutual fund is a fund in which investors cannot enter or quit until the fund’s term expires or during specific exit windows provided periodically. Most of the times these funds are listed on the stock exchanges, so there will be a platform for investors to exit the fund before the term ends if a close ended mutual fund is not listed in that case it is legally required to provide exit windows periodically. Only a predetermined number of units are issued by the fund during its initial launch. It is only available for subscription for a limited period. After that, anyone who wishes to invest in this fund can do so on the stock market (if it is listed).
Investors who subscribed to this fund during the NFO may sell their units on the stock exchange or redeem their units during periodic redemption windows. According to SEBI regulations, fund houses are required to provide investors with one of these two exit options.
Generally, closed-ended funds have a fixed term of about 5–7 years. However, investors can sell their units on the stock exchange if they want to withdraw from the fund if the funds are listed on the stock exchange. If a close ended fund is listed on a stock exchange and its units trade on the stock exchange, the number of outstanding units of a closed-end fund does not change.
Like any mutual fund, a closed-ended fund is launched through a New Fund Offering (NFO). By submitting an application within the allotted period, investors subscribe to this fund. The fund house lists the fund on the stock exchange once the NFO closes.
Now, investors buy and sell units of the fund on the stock exchange if it is listed on the stock exchange. However, the number of outstanding units will stay unchanged if it is listed. Additionally, the fund manager has the option to occasionally repurchase units from existing investors at NAV. The closed-ended fund’s value is determined by its NAV. However, the actual price is determined by the fund’s demand and supply. As a result, these funds may trade at a premium or discount to NAV.
Investors may remain invested in the fund until its maturity, which is generally between five and seven years. The relevant information will be provided during the fund’s launch.
The Advantages Of Investing In A Closed-Ended Fund
A few advantages of investing in a closed-ended fund are as follows:
- Stable Asset Structure: For these funds, units can only be redeemed on specific dates, i.e., when the fund matures or during specific redemption windows. This gives portfolio managers a steady asset base that is resistant to frequent redemptions. To put it another way, they don’t have to be concerned about the regular cash inflows and outflows. The fund manager will be able to develop a more comfortable investment strategy as a result of this. You can invest in mutual funds with Kuvera, which is among the best app to invest in mutual funds in India.
- Trading On The Stock Exchange: Most of these funds trade on stock exchanges just like equity shares. Investors can therefore purchase and sell the units in real-time. Market prices may be higher or lower than the fund’s NAV. Furthermore, they can use stock trading tactics such as market or limit orders and margin trading.
- They Are Not Illiquid: Although a closed-ended fund may first appear to have little liquidity since the fund house prohibits unit redemption, there are countless chances to acquire and sell the units on the stock exchange. In fact, closed-end funds provide investors with a high degree of liquidity. Units of a closed-ended fund are available to buy or sell on the stock exchange at the existing market prices if the close ended fund is listed.
Limitations Of Investing In A Closed-Ended Fund
A few disadvantages of investing in a close-ended fund are as follows:
- Only The Lump Sum Investment Option Is Available: The closed-ended scheme requires a lump sum investment because investors can only buy units during the initial launch period. This increases the risk. Additionally, a lot of investors use the Systematic Investment Plan (SIP) strategy because it is cost-effective and spreads risk.
- Highly Fund Manager Driven: Typically, investors examine the performance of a mutual fund scheme across different market cycles to determine whether investing in it is a wise decision. While this information is readily available for open-ended schemes, it is usually not available for closed-ended funds. Consequently, the fund manager’s decisions have a significant impact on the performance of the fund.
Frequently Asked Questions (FAQs)
- How are closed-ended mutual funds taxed?
Debt funds and equity funds are taxed differently. Therefore, in the case of Closed Ended Mutual Funds, the tax rates depend on the proportion of investments made by the scheme in equity and debt.