Close Ended-Mutual Funds: Features, Benefits & Who Can Invest?

Mutual funds

Close-ended funds are mutual funds with a fixed number of shares that are issued through single Initial Public Offering (IPO). All the capital is raised through this one offering and no new money will flow into the fund, thus making the number of shares fixed. The subscribers to the close ended funds are paid back after a specified period of maturity. Close-ended funds are overseen by a professional fund manager who analyzes the portfolio and actively buys, holds, and sells assets. 

Though close-ended and open-ended mutual funds work similarly, the main difference lies in the fact that they’re fixed and flexible respectively. Open-ended funds accept new investment capital and issue new shares accordingly. They buy back their own shares on-demand as well. This doesn’t happen in close-ended mutual funds. 

This post gives you valuable insights into close ended mutual funds, how they work, benefits, taxability and if you should invest. Read on!

How do Close-Ended Funds Work?

In close-ended funds, once the NFO (New Fund Offer) is completed, no additional units are allowed to be subscribed by the general public. Closed funds ensure that the fund manager always has a fixed amount of funds to work with, and thus provides a greater degree of freedom to the fund manager. On paper, close-ended funds should generate higher returns, when compared to similar open-ended funds.

Some close-ended funds are publicly traded in the stock exchange, allowing willing investors to purchase the units of mutual funds (thus effectively liquidating one’s position). Since no additional investments can be made after the NFO, SIPs are also impossible in this type of fund. 

Who Should Invest in Close-Ended Funds

Close Ended funds are suitable only for individuals with a 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. 

Also Read: Top Mutual Funds For Lump Sum Investments: Features, Benefits And Important Things To Consider

List of Close-Ended Funds

Here is a list of some of the most popular close-ended funds in India:

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.

Also Read: Mutual Funds & Section 80C: Here’s How Investments Can Save You Tax

Understanding NAV in Close-Ended Funds

Typically in an open-ended fund, the NAV (Net Asset Value) of the mutual fund is the price at which you buy one unit of that mutual fund. However, in the case of close-ended mutual funds, the NAV doesn’t necessarily reflect the price of the Unit. Since close-ended funds are usually traded in the secondary market, the market forces of supply and demand determine the pricing of the units. 

Should the fund perform exceedingly well, or be managed by a fund manager with a stellar track record there are high chances that the unit is traded at a price well above the NAV. 

However, on the other hand, if one particular close-ended mutual fund performs poorly, or has a history of high volatility, these units will only be traded at a discounted price. 

Benefits of Close-Ended Mutual Funds

• Greater Flexibility to the Fund Manager

As close-ended funds allow the fund manager to operate with a fixed amount of funds and without the necessity to maintain generous cash reserves to repurchase units of mutual funds, fund managers have a higher degree of control, flexibility, and freedom. In theory, close-ended funds should perform better than their open-ended counterparts. 

• Liquidity

While on the face of it, it may seem like close-ended funds are liquid (as redemption is not allowed till the date of maturity), secondary market trading in the stock market acts as a wonderful avenue for investors to liquidate their position, should the need arise. 

• Fair Pricing in the Secondary Market

The close-ended funds, since they’re priced purely based on the market forces of demand and supply, you’ll always have a fair valuation of how well the mutual fund is performing, at any given point in time. 

Disadvantages of Close-Ended Mutual Funds

1. Lesser liquidity than Open-ended Funds: While a certain degree of liquidity does exist, close-ended funds are not as liquid as open-ended funds. 
2. Asset Manager Bias: Asset Manager bias can be significantly high, and the dependence on the asset manager is also high in the case of close-ended funds. The performance of close-ended funds depends very heavily on the performance of a single asset manager. 
3. SIP not Available: One of the key advantages of Mutual Funds, is being able to invest systematically through SIPs is unavailable in the case of close-ended funds. 
4. Less-Than-Ideal Track Record: While, on paper, close-ended funds should outperform their open-ended counterparts, that is very rarely the case. Low-cost index funds have outperformed a majority of the close-ended funds in the market. 

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.

*Mutual Fund investments are subject to market risks, read all scheme-related documents carefully 

FAQs on Close-Ended Mutual Funds

1. Can I Invest in a close-ended fund after the NFO ends?/
   Technically, yes. You can purchase the units of the close-ended funds from one of the subscribers at the NFO. 
   
2. Can I begin a SIP in one of the close-ended funds?
   SIPs are not possible with close-ended funds. You can only invest lump-sum, and that too during the NFO.
   
3. I need to liquidate my close-ended funds immediately. Help?
   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. 
   
4. Will I be liable to tax on gains made by the sale of units of a close-ended fund?
   Yes, absolutely. Depending on the type of close-ended fund, you’ll attract different rates of taxes. 
   
5. Why should I Invest in a close-ended fund?
   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.