A mutual fund scheme with a predetermined fixed maturity period is called a closed-end mutual fund. Contrary to the open-ended funds, investors cannot redeem their funds before the maturity period. Closed-ended mutual funds are launched through New Fund Offers (NFO); subsequently, they can then be traded through stock exchanges. It is important to understand the structure, liquidity and associated risks before you take investment decisions.
Key Takeaways
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Closed-end mutual funds only allow subscriptions during the NFO period.
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Funds cannot be withdrawn once invested until the investment matures.
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The shares can be listed on recognised stock exchanges, and the traded price can be higher or lower than the actual price.
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Closed-ended mutual funds are suitable for long-term investors because of their low liquidity.
Closed End Mutual Fund Meaning
A scheme that has a fixed maturity period, closed-end mutual funds do not continuously issue and redeem stocks. You have to purchase stocks during the NFO; after that, the scheme would operate till it matures at a predetermined time. The stocks could be listed on stock exchanges, which allows investors to buy or sell them before they mature. However, selling said stocks depends on finding a suitable buyer at an acceptable price.
How Does a Closed End Mutual Fund Work?
The lifecycle of a closed-ended mutual fund begins with an NFO, during which you can subscribe to the scheme’s units. At its closing, the fund manager invests the money that was collected according to its stated objective. The stocks can then be listed on a recognised stock exchange platform where investors traded on its shares while the fund’s tenure is still active. Unlike open-ended schemes, investors cannot redeem their funds before the scheme matures.
Key Features of Closed End Mutual Funds
Closed-ended mutual funds are characterised by multiple distinct features:
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Fixed Corpus: The scheme collects its capital during the initial offering period instead of continuously accepting subscriptions.
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Fixed Maturity: Close-ended mutual funds operate for fixed predetermined periods.
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Exchange Listing: Post the NFO; stocks are listed on recognised stock exchange platforms in accordance with proper regulations.
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Professional Management: An asset management company manages the fund’s portfolio according to its investment objectives.
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Limited Liquidity: Closed-ended mutual funds have limited liquidity since funds cannot be withdrawn before the predetermined period ends.
Advantages of Closed End Mutual Funds
Closed-end mutual funds have a lot of advantages for investors, like:
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Disciplined Investing: The fixed maturity period encourages disciplined investment practices by not allowing frequent withdrawals within the predetermined period.
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Stable Fund Corpus: Closed-ended mutual funds neither accept multiple subscriptions throughout the investment period nor do they allow regular redemption, resulting in a stable fund corpus.
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Long-Term Investment Opportunities: Having a stable investment structure lets fund managers follow a long-term investment strategy which provides you with better long-term financial benefits.
Disadvantages of Closed End Mutual Funds
Closed-end mutual funds also come with certain disadvantages, like:
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Liquidity Constraints: You cannot redeem units directly from the fund before it matures after the predetermined time period.
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Market Price Fluctuations: Unit price changes depending on market trends and fluctuations in demand and can thus affect returns.
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Premium/Discount to NAV: Selling price often differs from the underlying value, as units can trade above or below their NAV or Net Asset Value.
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Lock-in Until Maturity: Funds are locked in till the maturity period; you can only trade the shares for a suitable price.
Closed End vs Open End Mutual Funds
Closed-end and open-end mutual funds differ in the following ways:
|
Feature |
Closed-End Mutual Fund |
Open-End Mutual Fund |
|
Liquidity |
Limited liquidity because of the fixed maturity period and difficulty in finding buyers for shares. |
Higher liquidity because of the open purchase and redemption options. |
|
Subscription |
Stocks are only offered during the NFO. |
Stocks can be bought at any point in time. |
|
Redemption |
Cannot be redeemed before maturity. |
Can be redeemed at any point. |
|
NAV |
Exchange price can differ from NAV. |
Transactions are generally based on the applicable NAV. |
|
Trading |
Stocks can be listed and traded on recognised stock exchange platforms. |
Transactions are generally made with the fund at the applicable NAV. |
|
Suitability |
Suitable for investors looking for long-term investments. |
Suitable for investors looking for more liquid options. |
Who Should Invest in Closed End Mutual Funds?
Closed-end mutual funds require a lump sum investment and are very less liquid as there are no redemption options before the maturity period is over, apart from trading the shares. If your investment horizon aligns with the maturity date and if you are comfortable with the associated risks and the long-term investment periods, then you can opt for investing in a closed-end mutual fund.
Factors to Consider Before Investing
For you to make an informed investment in a closed-end mutual fund, you should have a thorough understanding of the investment objective, the maturity period and the low liquidity of such mutual funds in comparison to their expenses. Assess the investment portfolio and the associated risks for such long-term investments. Only invest if you align with the maturity period and the longer redemption timeline.
Taxation of Closed End Mutual Funds
Taxation on equity and debt mutual funds is different; thus, the tax rates of closed-ended mutual funds are dependent on the percentage of investments made by the scheme in equity and debt. A fund is treated as an equity fund if 65% of its total assets are invested in equity or equity-related instruments. Meanwhile, if 65% of the total assets go to debt instruments, then it is considered a debt fund.
Conclusion
Mutual funds that have a predetermined maturity period are called closed-end mutual funds. These funds have a fixed maturity period during which investors cannot withdraw the invested amount but can sell their stocks at a recognised stock exchange. These are ideal investment opportunities for those looking for long-term investment options.
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