What is an NFO?
Initially, a mutual fund is launched through a New Fund Offer (NFO). NFO is the first time subscription for a particular mutual fund launched by the Asset Management Company. The objective behind launching an NFO is to raise capital for investing in equities and different financial assets.
Read here : All You Need to Know About NFOs
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 Closed-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 (SWPs) and Systematic Transfer Plans (STPs).
Read here : Top SIPs to Invest in 2019
Benefits of Close-ended funds
- Stability: Closed-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.