What are Closed-Ended Mutual Funds?

Investors in India prefer to put their money in mutual funds in order to get the maximum benefits from this market-linked investment tool. This is because of its many benefits, including the ability to build strong wealth over time. However, choosing the right type of fund can be challenging. If you want to diversify your portfolio, it is important to consider different types of mutual funds, including closed-ended mutual funds. Check out the blog to understand everything you need to know about closed-ended mutual funds in India, including their working and major benefits.

Meaning of a Closed-Ended Mutual Fund

Closed-ended mutual funds meaning is simple, they are funds that issue a fixed number of units during their launch. It means that the investors can buy these units only during the New Fund Offer (NFO) period and when the NFO ends, there can’t be any purchase or redemption of units. Rather, the units are listed on the stock exchange, where you can buy or sell them, similar to the working of shares. Also, make a note that the closed-ended mutual funds also have a fixed maturity period, like three to five years.

How Do Closed-Ended Mutual Funds Work?

Understanding how these funds work is important when considering them to diversify your portfolio. Here is how it all works:

• Once a fund house launches a closed-ended fund, it invites investors to subscribe during the NFO. When the subscription window closes, the fund collects the pooled money and invests it as per its stated objective (equity, debt, or hybrid).

• The investors can receive units that represent their share in the fund.

• These units are then listed on the stock exchange so that they can be traded according to the demand and supply.

Remember that the price of these units may be higher or lower than the Net Asset Value (NAV), which mainly depends on how investors look at the fund’s performance and overall market conditions.

Advantages of Closed-Ended Mutual Funds

Although it might seem that the closed-ended funds are restrictive, they come with a lot of benefits, such as:

• Stability for Fund Managers: As per closed-ended funds, the investors are not allowed to redeem their money before maturity and fund managers have a stable pool of assets to manage. This way, the inventors don’t need to worry about sudden withdrawals, leading to long-term opportunities.

• Opportunity for Higher Liquidity: With such funds in your portfolio, you get the opportunity for more liquidity. It means even though you cannot redeem units directly, you can sell them on the stock exchange. This way, you get added liquidity and flexibility.

• Market Price Opportunities: The units of closed-ended funds are traded like shares. If demand is high, the market price may be higher than the NAV. Investors can take advantage of this to sell at a profit.

• Disciplined Investment Approach: You can expect a disciplined way of investment in mutual funds with these funds because they don’t allow mid-way redemption or withdrawals, so this, in a way, is beneficial for you, for a sense of long-term discipline for better returns.

Disadvantages of Closed-Ended Mutual Funds

While the funds offer a lot of key benefits, you must also know about the disadvantages of closed-ended funds:

• Limited Access to Investments: The first con to know about is that these funds allow investment only during the NFO period. It means, if you miss the window, your only option is to buy from another investor through the stock exchange, which might not always be ideal.

• Performance History is Limited: When compared to open-ended funds, which offer a long history to properly analyse the track records, the closed-ended funds lack this data. In a way, it makes it harder for the investors to judge and make decisions.

• Lump Sum Investment Required: Investors must commit a lump sum amount during the NFO, this is because SIPs are not available. It may also increase the financial burden and risk for some investors.

• Dependence on Fund Manager’s Skills: Since investors cannot monitor performance as closely as in open-ended schemes, the fund’s success depends heavily on the fund manager’s investment strategy and decisions.

Who Should Invest in Closed-Ended Mutual Funds?

Closed-ended mutual funds are not suitable for everyone. They are best for:

• Investors with a long-term horizon who don’t need immediate liquidity.

• People with a lumpsum amount to invest rather than smaller periodic contributions.

• Investors are willing to take moderate risks while aiming for stable, long-term returns.

• Those who want to diversify their portfolio with equity, debt, or hybrid closed-ended schemes.

If you prefer flexibility and regular investments, open-ended mutual funds through SIP via leading banks like ICICI Bank might be a better option to invest.

Taxation on Closed-Ended Mutual Funds

The taxation of closed-ended mutual funds depends on whether the fund is equity-oriented or debt-oriented:

1. Equity-Oriented Funds: If 65% or more of the investments are in equities, the fund is taxed as an equity fund. Long-Term Capital Gains (LTCG) above ₹1 lakh are taxed at 10%, while Short-Term Capital Gains (STCG) are taxed at 15%.

2. Debt-Oriented Funds: If 65% or more investments are in debt instruments, they are taxed as debt funds. Gains are added to your income and taxed as per your applicable tax slab.

Disclaimer- Please read the offer document carefully to understand the tax implications before investing.

Tips to Keep in Mind Before Investing

When dealing with closed-ended mutual funds, consider these points:

• Understand Your Goals: Always invest if your financial goals match the maturity period of the fund.

• Check the Fund Manager’s Track Record: Remember to keep a check on the fund manager’s performance as it depends heavily on their decisions.

• Be Prepared for Price Variations: Market price may not always match the NAV, so plan accordingly.

Conclusion

Closed-ended mutual funds are a unique investment option that can help disciplined investors achieve long-term goals. By locking in funds for a fixed period, they allow fund managers to work with stability and focus on the fund’s objectives. However, they also limit flexibility, require lump sum investments, and depend heavily on the fund manager’s expertise.

If you are someone with a clear financial horizon, the ability to invest a lump sum, and the patience to stay invested until maturity, closed-ended mutual funds can be a good addition to your portfolio.