In India, there are two different types of mutual funds that you can invest in - open-ended mutual funds and close-ended mutual funds. These two kinds of funds are fundamentally and structurally different from one another. As an investor, you need to know what each of these funds is, and their advantages and disadvantages. In this article, we’re going to take an in-depth look at close-ended mutual funds. Continue reading to find out more.
A mutual fund scheme where the number of units is limited is termed a close-ended mutual fund. Such funds share quite a bit of similarity with an Initial Public Offering (IPO) of a company. In fact, the launch of a close-ended mutual fund is termed a New Fund Offer (NFO).
The New Fund Offer of a close-ended fund is only open for a limited period. Investors desirous of subscribing to the units of the fund should file their applications within the NFO period. To make it easier for the investors, the fund house publishes the price per unit and the maximum number of units available for subscription.
Once the New Fund Offer period expires, the company considers all the filed applications and allots the units to the investors who applied for them. In the case of oversubscription, the company allots the units on a pro-rata basis.
After allotment of the mutual fund units by way of credit into investors’ demat accounts, the units are then listed on stock exchanges. At this point, investors who subscribed to the issue can choose to exit by selling their units on the exchange to other investors.
Now, a close-ended mutual fund has a specific tenure. Upon maturity, the fund house dissolves the scheme and automatically redeems the units of the investors at the Net Asset Value (NAV) prevailing on the date of maturity.
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Now that you’re aware of what close-ended mutual funds are, let’s check out some of their advantages.
Once the New Fund Offer (NFO) expires, the fund house will not accept any new investments. Similarly, investors cannot redeem their mutual fund units before the end of the tenure. This completely cuts out both the inflow and outflow of funds and provides the fund house with some much-needed stability and a strong asset base. Thanks to such strong stability, fund managers don’t have to worry about maintaining liquidity and can take investment decisions without any fear.
As you’ve already seen before, the units of a close-ended mutual fund are listed on the stock exchanges after allotment. Investors desirous of a clean exit can choose to sell their units on the stock exchange at the prevailing Net Asset Value (NAV). The ability to buy and sell units of a close-ended fund at any time ensures that there’s no dearth of liquidity on the part of the investors.
Most close-ended mutual funds invest primarily in debt instruments whose maturities match that of the fund. Only a part of the fund value is invested in equities. This makes them ideal for investors with moderate risk-taking ability and those looking for stable long-term returns.
Although close-ended mutual funds have their advantages, they’re not without their share of risks or disadvantages. Here’s a glimpse of a few of them.
Unlike open-ended mutual funds which are perpetual, close-ended mutual funds are always newly launched funds. Due to this, there won’t be any track record of past performance to go by when investing in them. Investors will simply have to trust the fund house and the manager to deliver the returns and performance that they promised. Evaluating the worth of a close-ended mutual fund can be very hard due to this limitation.
Another major disadvantage of a close-ended mutual fund is that you can only invest a lump sum amount into it. Since you cannot invest any further once the NFO closes, there’s no question of a Systematic Investment Plan (SIP).
A close-ended mutual fund is not as common as an open-ended fund. However, that doesn’t mean that they’re not good investment options. On the contrary, if you’re looking for a stable investment option for the long term, then you may consider investing in a close-ended fund.
However, before you proceed to invest in one, you need to first open a demat account. Without it, you won’t be able to invest in the Indian stock market. Visit Motilal Oswal today to open a trading and demat account in your name. The account opening process is paperless and incredibly simple. You can complete it within just a few minutes and can have your account up and running in no time.