We can classify mutual funds mainly in three different categories, on the basis of
* Structure * Investment Objectives * Others.
On the basis of structure it can further be classified in three sub categories.
- Open ended funds 2 Close ended funds 3 Interval funds.
What is close ended mutual funds?
A mutual funds scheme where investment remains in lock in for certain specified period is known as close ended mutual funds. Investors can subscribe to these schemes only during the offer period and can redeem their units only after the lock in period or the tenure of the scheme. Some closed end funds becomes open ended after the completion of the lock in period. Investment experts argue that the closed end funds are ideal for long term equity investors because the lock in period ensures that the investor stays invested in the fund at least for a specified length of time which enables them to good capital appreciation. The other argument in favor of closed end funds is that the lock in period ensures that the asset under management (AUM) of the fund is stable which enables the fund manager to invest in stocks where there is long term value and growth potential, without worrying about redemption pressures.
Here in today’s article we will discuss about close ended mutual funds in detail. We will further discuss whether we should invest in close ended mutual funds or not?
In the year 2017 and 2018 about 40-45 close ended mutual funds had been launched by mutual fund companies and collected handsome amount from the market. As market was bullish these companies came out with various theme based close ended schemes. Starting with the value theme- which said stocks are available at discounts, make in India theme, manufacturing theme, resurgent India theme, etc. After the changes in political scenario, mutual fund houses had launched many close ended funds. Some houses have come out with multiple series of the same fund and collected good amount from the investors.
For asset management companies (AMCs) announcing close ended mutual funds makes good business sense. They get big amount and stable asset base for a longer or fixed tenure. Here they don’t have any redemption pressure. But with a view point of investors there are many drawbacks. Few of them are discussed below.
Why we should not invest in close ended mutual funds.
- No past records available for New Fund Offer (NFOs)
In open ended funds on the basis of historical data and performance of the fund in various market cycle, it becomes very easy for the investors to select particular scheme. In close ended funds no such data are available , so investors have to mainly depend on the fund managers and upcoming market events.
To make investors invest in some particular schemes, fund houses have to come up with excited, catchy and attractive theme. And here the name of particular fund becomes very crucial as it also should be attractive and catchy. Such schemes are launched as New Fund Offer (NFOs) so investors do not have historical data, comparison with peers, alpha generation with compared to benchmark, sector performance comparison, etc.
2. Low Liquidity
Once you are invested in such schemes, you can not withdraw or redeem money before specific time period. Even though funds performance is continuously coming down, you cant do anything.
However you may sell out your holdings on various stock exchanges, if you can find a buyer there as all the close ended funds have to be compulsorily listed on the stock exchanges. Being a close ended fund generally it traded at discounted rates than its present NAVs. And we also get very few buyers for close ended funds.
3.Role of Fund Managers
In close ended funds nothing can be worked out except name and fame of well-known fund manager. If we can invest in any fund by seeing big and expert fund manager’s name but what if (1) that fund manager left the job and (2) he shifted to manage other funds by management. So ultimately nothing can be worked out 100% in favour of investors. It will be just like throwing a leg ourselves on the axe.
4. It does not allow systematic purchase (SIP)
Generally close ended funds come up at a time when markets are doing well or in a bullish market. During such times it is very easy to convince customer for investing in mutual funds. But in rising market when valuations are also rising, investing in lumpsum could be a risky deal. Moreover, you never know which side markets will move from here onwards.
In such bullish scenario it is advisable to increase our postion in equities via syatematic route (SIP OR STP) . And in close ended funds it is not allowed as only one time lump sum investment is allowed. Close ended schemes require lump sum investments which may make an investor uncomfortable especially in falling markets when he could not even average out the investments by buying more.
5. Re balancing or Asset allocation is not possible
In mutual funds investing asset allocation and rebalancing plays very important role. Close ended mutual funds does not allow partial withdrawal, additional top up, SIP or STP. All this restrictions don’t go well in an asset allocation structure.
All those who makes investments with a clear structure and go through goal based planning must know the importance of asset allocation in mutual fund portfolio. In various market conditions switching from equity to debt and vice versa plays very important role, and such things are not allowed in close ended funds.
6. Only lump sum investment allowed
Here in close ended mutual funds only lump sum investments are being allowed. It is very difficult for salaried investors or small investors to keep a side a chunk of money in such funds. For such investors only systematic investments work magic.
Close-ended funds require you to invest a lump sum to buy the units of the fund at the time of their launch. This can be indeed a risky approach to deal with your investments. It exposes you to take bigger bets than otherwise warranted
7. No extra returns due to structure
Though product sellers claim many benefits of this close ended structure like it ensures commitment from investors for a specific time frame which helps fund manager to take risky calls. It also helps in managing portfolio better as investors have to stay put during both sides of the market and thus the greed and fear
Another claim they make is that it also helps in managing portfolio better as investors have to stay put during both sides of the market and thus the greed and fear do not guide the choice of investors. But even after these “so-called benefits” no significant performance has been witnessed in any close ended funds as compared to their open-ended peers.
Investors suffer from recency effect, which is a behavioral bias and leads people to believe that the recent happenings will continue for long. In financial markets, this can be gauged from the way the investments start pouring in due to recent stock market performance, and also when investors exit looking at the recent fall.
8. Compulsory redemption on maturity
Majority close ended funds refund investors money on the date of maturity in their respected bank account automatically. At the time of maturity even though market is negative or doing good, investor does not have a option to remain invested in those particular funds. Some of the funds convert close ended funds in to open ended funds from the date of maturity, but such feature must be informed in product prospectus or KIM before launching the scheme.
9. Less returns as compared to its open ended peers
Performance of the Closed-ended schemes has not been at par as compared to their open-ended peers across time horizons. You may know that the fund manager is in the favorable position due to restriction on redemptions. The lock-in period levied in closed-end funds which are aimed at giving the fund managers the flexibility to allocate the money without the fear of outflows has not helped much in generating better returns.
In this blog, we discussed the suitability of closed end funds as investment options. Weather you should invest in the same or not. Like with all mutual fund investments you must ensure that you have selected the right fund that is suitable for your long term objectives. A number of closed end schemes are on offer now. You should discuss with your financial adviser, if you these schemes are suitable investment options for you.