A mutual fund is launched through a New Fund Offer (NFO). If you apply during this period, you will get fund units at the NFO price (such as Rs. 10 or Rs. 100). A close-ended fund is the fund which does not allow entry and exit of investors after the NFO period, until maturity. This is typically 3-4 years from the launch date. Whereas, open-ended funds are the funds which allow investors to enter and exit the fund anytime after they are launched. An open-ended fund is officially launched after the NFO ends.
Close-ended Funds v/s Open Funds
Apart from the difference between subscription and redemption periods, close-ended funds and open-ended funds have a few more differences. The close-ended funds do not provide investors the option of making an investment via a systematic investment plan (SIP) by virtue of the limited periods during which they allow investments. Similarly, as the periods for redemption are also limited, close-ended funds also do not support systematic withdrawal plans (SWPs) and systematic transfer plans (STPs). Moreover, unlike open-ended funds, close-ended funds come with inherent illiquidity. You can buy and sell units of such a close-ended funds on the stock market in theory, but liquidity in such funds on the market tends to be low.
Benefits of Investing in Close-ended Funds
New strategies: Close-ended funds offer you the chance to invest in new and innovative strategies that existing open-ended fund may not offer.
Flexibility: Close-ended funds provide you flexibility in terms of when you choose to invest your money in the market. In other words, even if the investment timing is bad and the fund is launched at a market peak, the fund manager can hold on to your funds and invest some of them a little later. This flexibility helps fund managers of such funds in outperforming the market.
Freedom from large flows: Open-ended funds are vulnerable to large inflows and outflows. A sudden outflow can force the fund manager to sell his stocks at rock-bottom prices, causing a loss to all unit holders in the fund. Whereas, investors in a close-ended fund are locked-in for the tenure of the fund and the manager can focus on stock selection and monitoring. You can only invest in a close-ended fund through an NFO.
Lock-in support: A much heeded investing proverb says that ‘time in the market is more important than timing the market’. Most equity fund investors stay invested for only two years in the market, greatly impairing their returns. This is simply because it is difficult for investors to stay immune from market panics and manias. However the lock-in provided by close ended funds of 3-4 years acts as a break, preventing investors from falling prey to bad investing behaviours.
Who Should Invest in Close-ended Funds?
Close-ended funds are suitable for investors seeking investments for a defined horizon who do not need their money for that time horizon.The limited time period reduces the chances of investors panicking and redeeming at a loss during falling markets. Close-ended funds usually have to be held till maturity which can be for a period of 3 to 10 years depending on the specific type of fund. This ensures that these investments are held for at least medium to long term. This tends to benefit investors as staying invested for a longer time period is one of the best ways of ensuring that one makes adequate capital gains from his/her investments.
The other groups of investors who can choose to invest in close-ended funds are existing investors looking to diversify their portfolio further. This is because many close-ended funds have unique features in terms of the type of investment or management/fund selection styles. These unique styles and investment methods help ensure that the fund offers unique diversification options that cannot be adequately provided by the available open-ended funds. However, such benefits should only take centre stage when the investor has sufficient liquidity and does not need to consider divesting close-ended funds for meeting his/her current liquidity requirements.
Recently Launched Close-ended Funds
Reliance India Opportunities Fund: Reliance Mutual Fund started the NFO of the Reliance India Opportunities Fund on September 7, 2018 and and closed it on September 27, 2018. The fund uses S&P BSE 200 Index as it benchmark. The minimum investment amount for the fund stood at Rs. 5,000.
SBI Dual Advantage Fund: SBI Mutual Fund initiated the NFO for the SBI Dual Advantage Fund on September 27, 2018 and closed it on October 5, 2018. The fund uses CRISIL MIP Blended Index as its benchmark. The minimum investment amount for the fund stood at Rs. 5,000.
Tax Treatment of Close-ended Funds
The tax treatment of a close-ended fund will depend on whether it is an equity fund or a non-equity fund. You can read about taxation of equity mutual funds and non-equity mutual funds here.