Close-Ended Funds: Difference, Benefits & Features

What are Close-Ended Mutual Funds?

A close-ended fund is a kind of mutual fund that pools resources from numerous investors through issuance of New Fund Offer (NFO). An investor buys units of the fund during the NFO period. The units are sold at a price based on Net Asset Value of the mutual fund that is launching the NFO.

Close-ended fund raise a fixed amount of capital through NFOs. After that no fresh unit can be bought from the fund house but the issued units can be traded on listed stock exchanges.

How Does Close-Ended Mutual Funds Work?

After an asset management company launches New Fund Offer (NFO), an investor buys units of the fund at a specific price. No new investor can enter the fund after the NFO period is over. Also, investors are not allowed to exit the fund before the maturity of the scheme.  The maturity period typically ranges from 3-4 years.

Investors who want to exit the fund before maturity, can trade their units on stock exchanges. Closed end funds’ units are traded on stock exchanges just like any other public security. The price of the units vary according to market fluctuations and performance of the concerned investment portfolio of the scheme.

Sometimes close-ended funds trade at a discounted price on their Net Asset Value (NAV). New investors can capitalize on this difference to earn decent returns in the future, as redemptions on maturity happens at NAV.

Difference Between Open-Ended Funds vs Close-Ended Funds

Apart from entry and exit restrictions, there are various other differences between Close-ended funds and Open-ended funds. An open ended fund is officially launched after the NFO period is over. Investors can enter and exit an open-ended fund as per their wish and needs.

Unlike open-ended funds, close-ended funds do not have the facility of investment via Systematic Investment Plan (SIP) because of limited period of NFO. Also, close-ended funds do not support Systematic Withdrawal Plans SWP and Systematic Transfer Plans (STPs).

Read here : Top SIPs to Invest

Benefits of Close-ended funds

• Stability: Close-ended funds are stable in terms of their asset valuation. During the NFO period, these funds accumulate a rigid asset base. Fund managers need not worry about further redemptions and changes in total assets of the fund. They can invest in equity, debt securities and other financial assets as per the market movements.
• Freedom from large flows: Unlike open-ended funds, close-ended funds are immune to large inflows and outflows. A sudden outflow of money from the fund forces the fund manager to take impulsive decisions and sell the securities at rock-bottom prices. In case of close-ended funds, investors’ money is locked-in until  maturity which allows the fund manager to make rational decisions.
• New opportunities: Close-ended funds allow investors to invest in new and innovative strategies which the already existing open-ended funds do not offer.
• Trading on Stock Exchanges: Investors have the option of trading their units of close-ended funds on stock exchanges. The trading price can be below or above the Net Asset Value of the fund. One can strategize like stocks trading to capitalize on their investments in their close-ended funds.

Who Should Invest in Close-ended Funds?

Investors who have a long term investment horizon and do not need the invested money during that horizon should invest in close-ended funds. The lock-in condition of the fund negates the possibility of any impulsive decision by investors in times of turbulent market conditions.

This lock-in period until maturity ensures that investors make adequate capital gains on their investment.

Investors looking to diversify their portfolio should also consider close-ended mutual funds for investment as they have unique features in terms of the type of investment or management/fund selection styles.

Frequently Asked Questions

Q.1: How do you sell a Close Ended Mutual Fund?

Ans: Close-ended Mutual Funds operates like an Exchange-Traded Fund, listed on the stock exchange and traded in the secondary market. You can sell a close-ended mutual fund in the same way as you buy or sell stocks. The broker will quote you the prevailing market price and the competition price of a close-ended fund after which you can decide whether you would like to sell the share at the prevailing price or quote a lower/higher price.

Q.2: What happens when a closed end fund liquidates?

Ans: Liquidation of Mutual Funds occurs due to poor performance of a fund over a period of time. When a close-ended fund liquidates, it liquidates the assets and distributes the equity of the fund amongst the shareholders. The shareholders are then forced out of the investment and embedded capital gains taxes are also borne by them.

Q.3: How are close ended funds taxed?

Ans: For close-ended Equity funds: If you sell the mutual fund units after 1 year from the date of investment, capital gains up to Rs. 1 lakh are exempted from taxes. Capital gains more than 1 lakh are taxed at 10%. And, if you sell the mutual fund units before completion of 1 year of investment, 15% tax is levied.

For close-ended Debt funds or Hybrid funds: If you sell the mutual fund units after 3 years from the date of investment, capital gains are taxed at 20% after indexation benefit. And, if you sell the mutual fund units within 3 years from the date of investment, the capital gains are added to the investor’s income and taxed according to the tax slab.

Q.4: What are the advantages of closed end funds?

Ans: Some of the advantages of closed end funds are-

1. Close-ended Mutual Funds can be bought and sold throughout the trading day which can benefit you with short-term trading opportunities.
2. Units of Mutual Funds can be purchased at discounts to the net asset value.
3. Just like stocks, closed-end funds are listed on the stock exchange which allows the investors to keep a check on the price movements in the market easily.
4. Capable of giving high yields than open-ended funds
5. Professional Fund management ensures stability in the pool of capital. The managers of closed-ended funds often seek broad diversification to minimise risk
6. You can also benefit from the leverages (borrowed capital) to increase your assets and maximise returns.

Q.5: Do close ended funds have expense ratios?

Ans: Yes, close-ended funds do have expense ratios just like other mutual funds. The expense ratio of a close-ended fund ranges from 0.25% to 2% or higher. In case of non-leveraged closed-end funds, the expense is calculated only against net assets. While in case of leveraged closed-end funds, the expense is calculated against net assets as well as leveraged assets (borrowed assets).

Q.6: Do closed end funds pay dividends?

Ans: Yes, close-ended funds pay out the profits in the form of dividends to their investors. These dividends are paid to the investors on a monthly or quarterly basis depending on the fund’s underlying holdings.

Here is a List of Closed End Mutual Funds you can Invest

Fund Name	Fund Assets (Cr)	1 Year Return	3 Year Return	5 Year Return
SBI Small Cap Fund	2,704	8.33%	11.28%	17.04%
Mirae Asset Emerging Bluechip Fund	8,219	18.27%	14.40%	17.53%
Canara Robeco Emerging Equities Fund	5,235	10.38%	11.25%	13.89%
Nippon India Small Cap Fund (earlier Reliance Small Cap Fund)	8,425	-2.60%	8.14%	11.82%
Kotak Emerging Equity Scheme	4,960	11.35%	8.38%	12.89%
ICICI Prudential All Seasons Bond Fund	2,816	11.28%	8.24%	9.91%
Franklin India Dynamic Accrual Fund	4,012	9.51%	9%	9.98%
SBI Magnum Medium Duration Fund	1,942	11.77%	9.31%	9.80%
Axis Strategic Bond Fund	1,188	8.32%	7.68%	9.11%
PGIM India Dynamic Bond Fund	42	13.69%	9.32%	10.08%
Axis Long Term Equity Fund – Direct Plan	21492	18%	18%	12%
Axis Bluechip Fund – Direct Plan	8749	22%	21%	11%
Axis Long Term Equity Fund – Growth	21492	17%	16%	11%

Data as on 08th December 2019: Source- Value Research)