What are Close-Ended Mutual Funds and How do They Work?
Mutual funds can be broadly categorised into two categories based on their maturity periods – open-ended and close-ended funds. Traditionally, most people invest in open-ended schemes, because they offer liquidity. But these days, many investors are drawn to close-ended mutual funds as they offer fund managers more freedom to deliver better performance in terms of returns. Let’s discuss the features and functionalities of close-ended funds in detail.
What are Close-Ended Mutual Funds?
As per the definition provided by the Securities and Exchange Board of India (SEBI), close-ended mutual funds are mutual funds that come with a fixed maturity period. Investors can subscribe to a close-ended scheme only during NFO (New Fund Offer) period. Once the NFO ends, investors cannot buy or redeem units of close-ended funds. The fund units can only be redeemed once the lock-in period is over. This works in advantage of fund managers as they have more freedom to unlock the potential of the fund.
Point to note: Close-ended funds can get converted into open-ended schemes after their tenure is over.
How Does a Close-Ended Fund Work?
A fund house launches close-ended funds during NFO. Only a fixed number of mutual fund units are issued during launch and traded in the market with a fixed maturity period. This is the period during which investors can buy or redeem units. Once the NFO ends, investors cannot buy or redeem units until the maturity period is over. You cannot invest via SIPs for close-ended funds since investments can’t be made after NFO.
Features of Close-Ended Mutual Funds
Some of the important features of close-ended mutual funds are as follows:
- The option of liquidity does not exist during the lock-in period. You can redeem the fund units only after the lock-in period comes to an end.
- You can invest in close-ended schemes during the new fund offer (NFO) only and because of this feature, no track records are available. In addition, you cannot invest in these schemes through SIPs (Systematic Investment Plans).
- The averaging facility is not available for these mutual funds as you will not be able to invest in these schemes after the NFO period is over.
- Generally, the minimum investment amount allowed for close-ended schemes is ₹5,000.
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Benefits of Close-Ended Mutual Funds
Listed below are the benefits of investing in close-ended funds:
1. Offers Stability
A major benefit of a close-ended mutual fund is its stability in terms of asset evaluation, which is the result of its strict lock-in period. It helps fund managers formulate investment strategies and accumulate a steady asset base.
2. Trading on the Stock Market
You can trade your close-ended mutual fund units on the stock market just like equity shares. The trade is based on real-time prices and the trading price can be either above or below the Net Asset Value (NAV) of the fund.
3. Fund Managers Have More Freedom
These schemes enable fund managers to make rational decisions as close-ended mutual funds do not get affected by large inflows or outflows. As a result, these funds do not have to hold a part of their assets in cash to cover redemption requests.
4. Potential to Create Unique Portfolios
Moreover, the lock-in period also enables the fund manager to create unique investment portfolios by adding undervalued debt and equity securities.
5. Fair Valuation
Since close-ended funds trade on the stock exchange, their prices depend entirely on their market supply and demand. This means you can easily assess their fair valuation.
Who Should Invest in Close-Ended Funds?
Close Ended funds are suitable only for seasoned investors with significant corpus, and the patience to wait till the maturity date of the close-ended fund. Most close-ended funds require lump-sum investments, and cannot be redeemed until the date of maturity.
The risk-reward expectations will vary based on the underlying assets the close-ended fund invests in. Each close-ended fund is different and requires independent research on the scheme before investing in one.
How to Invest in Close-Ended Funds?
Given below are the steps to invest in close-ended funds:
- Step 1: Open a mutual fund account with an AMC.
- Step 2: Complete all your KYC (Know Your Customer) formalities.
- Step 3: Provide every required detail.
- Step 4: Select the mutual fund you wish to invest in based on your financial goals, preferred investment tenure and risk appetite.
- Step 5: Transfer the required amount to the close-ended scheme.
List of Top Close-Ended Funds in India in 2023
Here is a list of some of the most popular close-ended funds in India in 2023:
| Close-Ended Mutual Fund | NAV | AUM | Expense Ratio | 5-Year Annualised Returns |
| SBI Tax Advantage Fund – Series III – Regular Plan | ₹48.8199 | ₹30.57 crore | 2.7% | 19.48% |
| Mirae Asset Emerging Bluechip Fund – Growth | ₹96.876 | ₹24,054.79 crore | 1.7% | 12.38% |
| Canara Robeco Emerging Equities – Regular Plan – Growth | ₹159.99 | ₹15,499.66 crore | 1.78% | 9.97% |
| Nippon India Small Cap Fund – Growth | ₹92.7691 | ₹23,765.05 crore | 1.83% | 13.33% |
| Kotak Emerging Equity Fund – Growth | ₹76.04 | ₹23,334.64 crore | 1.72% | 12.21% |
*Data valid as of 15 January 2023
Taxability of Close-Ended Funds
Depending on the securities invested by the mutual fund, the treatment of gains in taxation varies as follows.
For equity-oriented close-ended funds (where >65% of total assets invested in equity/equity-related investments):
- Short Term Capital Gains – In case the units of the mutual funds are sold off within 1 year from the date of purchase – 15% STCG
- Long Term Capital Gains – If the units of the mutual funds are sold off after 1 year from the date of purchase – 10% LTCG
All other funds:
- Short Term Capital Gains – In case the mutual fund units are sold off within 3 years of the date of purchase – taxable according to the tax bracket.
- Long Term Capital Gains – Selling mutual fund units off after 3 years – 10% without indexation benefit or 20% with indexation benefit.
It is strongly recommended that you calculate the tax necessary to be paid using both methods, before choosing whether or not it’s suitable for you to opt for indexation benefits.
Final Word
Close-ended funds are ideal for people who trust a particular fund manager to lock in a lump sum amount for a specific period of time. Usually, for close-ended mutual funds, liquidity is only provided through the secondary market. These funds usually tend to come with a higher expense ratio, much unlike Navi’s wide array of mutual fund schemes – which come at a low expense ratio, thanks to our tech-driven approach. To start investing, visit Navi Mutual Fund.
You can consider investing in close-ended mutual funds if you do not have any problem with a strict lock-in period. These schemes provide a lot of benefits. For instance, fund managers can create unique portfolios as these schemes are not subject to inflows and outflows. However, do adequate research and understand the risks involved before investing in close-ended funds.
Planning to invest in mutual funds? Start investing in Navi Mutual Fund schemes. What you get – low-cost funds across sectors and geographies, exposure to international market, investments starting at Rs.10 and more. Invest now to secure your financial life.
FAQs
Ans: Technically, yes. You can purchase the units of the close-ended funds from one of the subscribers at the NFO.
Ans: SIPs are not possible with close-ended funds. You can only invest lump-sum, and that too during the NFO.
Ans: It is a common misconception that close-ended funds are illiquid. You can always sell the units of close-ended funds in the stock market.
Ans: Yes, absolutely. Depending on the type of close-ended fund, you’ll attract different rates of taxes.
Ans: There are several key benefits of a close-ended fund, including the possibility of higher returns thanks to the greater degree of flexibility given to the fund manager.
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
