Understanding Closed Ended Funds

Closed-ended-funds are one type of investment that can be a bit different from the usual mutual funds. Such funds issue a certain number of units at the very outset, and once the launching period is over, no more units could be purchased or sold directly from the fund. Instead, they are traded in the market like stocks. The price of the units can be higher or lower than the actual value of the fund, depending on how many people want to buy or sell.

What Makes Closed Ended Funds Special?

• Stability for Fund Managers
  In closed-ended funds, investors are not allowed to redeem their units before the maturity date. This gives the fund manager a stable amount of money to work with, allowing them to focus on long-term investment strategies and asset allocation without worrying about unexpected withdrawals.
• Market Price Fluctuations
  Unit prices of closed-end funds are directly proportional to demand and supply conditions in the market. The prices will go higher, even sometimes above their values, if many people want the units more than selling them. Conversely, demand falling will also make the prices drop.
• Stock Exchange Liquidity
  Although it would appear that closed-ended funds are illiquid because they do not have redemption opportunities before maturity, you can still sell and buy units in the stock exchange. This will give more ways to trade for investors although this is not as flexible as in open-ended funds.
  Benefits and Risks

Advantages of Closed-Ended Funds

Closed-ended-funds provide unique advantages to them to attract specific investors in India. They offer stability and growth opportunities while navigating the problems of volatility in the market.

1. Stability for Fund Managers

Since investors cannot withdraw their money before the maturity date, the fund managers have a stable asset base. They can focus on long-term investment strategies, without worrying about the sudden withdrawal of investments. This stability assists fund managers to make better decisions, thus improving risk management.

2. Opportunity for High Returns

The fixed investment period allows fund managers to invest in assets that may take longer to grow. This leads to capital gains and high yields over time, especially when the market performs well. Unlike open-ended funds, these funds are not affected by frequent buying and selling pressures.

3. Market-Driven Pricing

Units of closed-ended funds are traded on stock exchanges like equity shares. The price of units depends on market demand and supply, which means investors can sometimes sell their units at a premium. If the demand is high, investors may earn more than the fund’s actual Net Asset Value (NAV).

4. Better Asset Allocation

Fund managers can diversify investments across different sectors to maximize returns. They need not keep some money aside to withdraw suddenly; they can therefore focus on an asset allocation plan. A well-diversified portfolio reduces the risks and chances of dividend income.

5. Liquidity through Stock Exchange

Though investors can’t redeem units from the fund, they can buy or sell them on the stock exchange. This provides them with liquidity and an opportunity to exit before maturity date if they want. Investors can capitalize on market fluctuations by selling their units at higher price.

6. Less Impacted by Market Volatility

Because investments are held in the fund for a specified time, closed-ended funds are not much influenced by short-term market volatility. This is one reason why closed-ended funds are a good choice for investors seeking stability in volatile markets.

Closed-ended funds are one of the best choices for those with a long-term vision who seek to gain through capital gains, asset allocation, and high yields. However, it is imperative to know what risks lie behind and to check whether the investment is according to your financial goal.

Disadvantages of Closed Ended Funds

High returns are associated with close-ended funds; however, their asset allocation is structured, along with specific drawbacks. All such drawbacks make one take prudent decisions about their investment.

1. Lack of Investment Flexibility

Closed-ended funds can only be purchased once when the company makes an initial offer. Later on, they do not accept fresh funds; in fact, it is impossible for investors to start investing by installing SIPs over time.

This can make the adjustment of the investment strategy concerning the volatility in the market extremely challenging.

2. Dependence on Market Demand and Supply

The price of closed ended fund units is decided based on the demand and supply and not its actual value in the fund. Low demand could lead to a selling price at a price that is lower than the NAV for investors, with possible capital loss.

Unlike open-ended funds where the fund house provides liquidity, here, the selling of units depends on the market conditions.

3. Risk Due to Investment in Lump Sum

Closed-ended funds require investing a lump sum at the onset of investment and hence increase the financial risk. The market decline may affect returns and investors can’t withdraw from an investment at any point without selling units in the secondary market.

Investors who prefer investing systematically may find this structure unsuitable for the management of risks.

4. Performance Is a Direct Function of Fund Managers

The performance is heavily dependent on the fund managers as the investors cannot make adjustments once invested in the funds.

Closed-ended funds do not have enough long term historical data which is unlike the open-ended funds where past performance data over various market cycles are available.

Badly managed fund leads to a low dividend income and lower capital gains.

5. Less Liquid Than Open-Ended Funds

Investors cannot redeem their units before maturity, that makes these funds less liquid. The units can be traded on the stock exchanges, but low trade volumes become a hassle to get out at the price of interest. This may become an inhibitor at times of urgent financial requirement.

Closed-ended funds have a higher return yield and a structured asset allocation. However, it carries with it market risks, fund manager dependency, and lack of liquidity. One needs to take the necessary steps before investing to see whether or not this kind of investment can align with their financial goals, coupled with appropriate risk management.

Who Should Invest in Closed-Ended Funds?

Closed-ended funds can be an excellent option for the specific type of investor in India. This is because the funds demand the kind of lump sum investment along with a fixed maturity date; hence, this investment will only suit investors who can invest until the maturity date.

Suitable Investors for Closed-Ended Funds

1. Long Term Investor

These funds do not allow early withdrawals and the money lies locked away, making such investments perfect for investors who have some long-term financial goal.

Investors looking for capital gains over a fixed period may benefit from staying invested.

2. Investors Seeking High Yields

Closed-ended funds can offer high yields if managed well.

The fund manager has the freedom to implement strong investment strategies without worrying about frequent redemptions.

3. Those Comfortable with Market Volatility

Since these funds are traded on the stock exchange, their prices can fluctuate based on demand and supply.

Investors who can absorb short-term fluctuations in the price of the security and understand market volatility may be able to appreciate these funds.

4. Those Seeking Dividend Income

There are some closed-ended funds that pay regular dividends, thus being appealing to those investors seeking periodical income.

However, it depends on the performance of the fund and market conditions.

5. Risk-Averse Investors

These funds include risk management techniques, but because the money is locked until maturity, investors have to be okay with market fluctuations.

Selecting funds with a good asset allocation balance can reduce the risk factor.

Tax on Gains in Closed Ended Funds

Taxation varies with the design of the fund:

• Equity-Oriented Funds: If a fund has 65% or more invested in equities, it is taxed like an equity fund.
• Debt-Oriented Funds: If a fund invests at least 65% in debt instruments, then it is treated as a debt fund for taxation purposes.

Always check the offer document before investing to understand the tax implications and asset allocation of the scheme.

Performance of Closed Ended Funds in India

Here are some examples of closed-ended funds in India, showing their returns over the last few years:

Name of the scheme	Returns
	1 year	3 year	5 year
SBI Tax Advantage Fund – Series III – Regular Plan	2.61	9.60	13.02
ICICI Prudential Growth Fund – Series 2	3.31	10.98	12.99
SBI Tax Advantage Fund – Series II	-2.26	9.68	12.88
ICICI Prudential Growth Fund – Series 1	4.39	9.08	11.83
ICICI Prudential R.I.G.H.T. Fund	-12.14	6.99	10.00
Reliance FHF XXV Series 15	8.28	8.38	9.00
HDFC FMP 793D Feb 2014 (1) Reg	8.97	7.32	8.42

These funds work differently under different circumstances, like market conditions, investment strategies, and asset allocation.