Closed Ended Mutual Funds : Meaning, Features & Suitability

What are Closed-Ended Mutual Funds?

Closed-ended mutual Funds are defined as a specific type of investment idea characterised by a fixed number of shares or units issued during the fund’s initial public offering (IPO). Closed-ended Mutual Funds are defined as a unique type of investment option, in the world of mutual funds. Unlike open-ended funds that allow investors to buy and sell units whenever they want, closed-ended funds have a fixed number of units and are often listed on stock exchanges.

Features of Closed-Ended Mutual Funds

1. Fixed Unit Structure: Closed-ended mutual funds issue a specific number of units during the IPO, and this quantity does not change after the initial offering. Investors buy and sell these units on the secondary market.

2. Market Trading: Units of closed-ended mutual funds are traded on stock exchanges like individual stocks. Investors can buy or sell these units at prevailing market prices, which may differ from the Net Asset Value (NAV) of the fund.

3. Limited Liquidity: Compared to open-ended funds, closed-ended mutual funds typically have lower liquidity. Investors can only sell their units on the secondary market, and the ease of trading depends on market demand.

4.Fixed Lifespan: Closed-ended mutual funds often have a predetermined lifespan, which is specified in the fund’s prospectus. At the end of this period, the fund is dissolved, and investors receive their share of the remaining assets.

5. Initial Public Offering (IPO): The fund is launched through an IPO where a fixed number of units are offered to the public. Investors can participate by purchasing units at the initial offer price.

6. Market Price Determination: The market price of closed-ended mutual fund units is determined by supply and demand in the secondary market. Units may trade at a premium or discount to the NAV, providing opportunities for investors.

How Closed-Ended Mutual Funds Operate?

Closed-Ended Mutual Funds work with a predetermined fixed number of units. Unlike open-ended funds where units are created or redeemed based on investor demand, closed-ended mutual funds begin with an initial public offering (IPO) to raise capital. Once the IPO phase is completed new investors cannot join the fund anymore. The number of units remains constant. Following the IPO phase, investors can sell closed ended mutual fund units, on a market typically through a stock exchange. The price at which these units are bought and sold in the market depends on how many people want to buy them and how many of them are available. This can cause the units to be traded either at an lower price, than the value of the funds assets. Closed ended mutual funds often have a predetermined lifespan, after which they are dissolved and investors receive their fair portion of the funds assets.

Advantages of Closed-Ended Mutual Funds

1. Benefits of Market Pricing: One advantage of ended funds is that investors can purchase units at a price determined by the market. This may allow them to buy units at a cost compared to the asset value (NAV) giving them a potential cost advantage.

2. Portfolio Stability: The closed structure of these funds ensures that fund managers are not obligated to make trades in response, to investor redemptions. As a result the portfolio tends to be more stable and less subject to changes.

3. Expert Management: Similar to ended funds, closed ended mutual funds are overseen by fund managers. This gives investors access to management expertise.

4. Diversification Benefits: Closed-ended mutual funds offer diversification advantages by investing in a wide range of assets. This helps spread risk across asset classes and issuers.

Disadvantages of Closed-Ended Mutual Funds

1. Limited Liquidity: Compared to open-ended funds, closed-ended mutual funds generally have lower levels of liquidity. Investors can only sell fund units on the market and the ease with which they can be traded may vary based on the popularity of the fund.

2. Potential for Discounts: Closed-ended mutual funds can sometimes trade at prices below their NAV. This means that investors might be able to purchase units for less, than the value of the underlying assets. This could lead to a loss of capital if the discount increases.

3. Limited Portfolio Flexibility: The portfolios fixed nature limits the fund managers ability to adjust to market changes or seize emerging opportunities.

4. No Sales: Once the initial public offering (IPO) phase concludes, closed-ended funds do not continuously offer new units, for sale. Investors need to wait for opportunities, in the market.

Who Should Consider Investing in a Closed-Ended Mutual Fund?

1. Long Term Investors: Individuals with a long term investment outlook who are not overly concerned about liquidity matters may find closed ended mutual funds attractive.

2. Value Oriented Investors: Those following a value investment approach, who can benefit from purchasing units at a price than the Net Asset Value (NAV) might find closed ended mutual funds intriguing.

3. Experienced Investors: Seasoned investors who have an understanding of market dynamics and can analyse discounts and premiums may feel more comfortable with close-ended mutual funds.

4. Stability Seekers: Individuals who prioritise the stability provided by a fixed portfolio and are less focused on market timing could find closed ended mutual funds aligning well with their investment strategy.

Taxation on Closed-Ended Mutual Funds

The tax treatment of ended funds varies depending on the jurisdiction. For instance in India, the tax implications for ended funds are as follows:

1. Capital Gains Tax: Capital gains derived from ended funds are subject, to taxation. The tax rate varies depending on how you hold your investment. If you sell your units within a year you will be taxed at the income tax rate. If you hold them for more, than a year the tax rate is lower and comes with indexation benefits.

2. Dividend Distribution Tax (DDT): When it comes to closed ended funds in India they are not required to pay Dividend Distribution Tax (DDT). Instead the responsibility of paying taxes on dividends falls on the investor. The amount of tax paid will depend on the tax slab.

3. Securities Transaction Tax (STT): Ended funds are also subject to Securities Transaction Tax (STT). This means that investors need to pay STT when they buy or sell units, in the market.

List of Closed-Ended Mutual Funds in India

Here are a few examples of funds, in India that have a fixed duration:

1. ICICI Prudential Value Fund – Series 20: This equity fund offered by ICICI Prudential Asset Management Company allows investors to diversify their portfolio by investing in value oriented equities.

2. HDFC Housing Opportunities Fund: This ended fund focuses on real estate investments aiming to provide long term capital appreciation to investors.

3. Kotak Tax Saver Scheme Series 4: This equity linked saving scheme (ELSS) offers tax benefits while also targeting long term capital growth.

4. Nippon India FHF Series 11: This fixed horizon fund from Nippon India Mutual Fund aims to generate capital appreciation by investing in a mix of equity and equity related instruments.

5. SBI Debt Fund Series C-5 (1237 Days): This debt fund focuses on generating income and capital appreciation through investments, in fixed income securities with a defined maturity.

Conclusion

To sum up closed ended mutual funds provide investors with an investment choice catering to those who prioritise market pricing, portfolio stability and the chance to acquire units at a discount. Although these funds offer benefits, like expert management and diversification it is crucial for investors to also weigh the drawbacks of liquidity, potential discounts and the fixed nature of their portfolios.