Should you invest in close-ended equity funds?

Source: timesmoney

With a host of close-ended equity funds’ NFOS being announced, you may be wondering whether they are worth considering. Your question answered…




Have you noticed a number of advertisements these days from mutual funds inviting you to subscribe to their new ‘close-ended’ schemes? Before you decide to invest, it is important that you understand the scheme and its ‘close-ended’ nature.

There are two kinds of mutual fund schemes – (1) open-ended funds and (2) close-ended funds. An open-ended fund is a scheme that exists till perpetuity and offers fresh units to new investors even after the scheme closes its initial offering. On the other hand, a close-ended fund exists for a specific period of time and does not offer fresh units to new investors after it closes its initial offering. Both schemes make available redemption of units to investors who have invested during the initial offering.

Recently, a number of schemes have been launched as ‘close-ended’ schemes for a specific tenure after which they become open-ended. Consider the ‘SBI One India Fund’ launched by SBI Mutual Fund. This scheme is a 3-year close-ended fund, which becomes open-ended at the end of 3 years. Similarly, LIC Mutual Fund has launched the ‘LIC MF India Vision Fund’, a 3-year close-ended equity fund, which becomes open-ended at the end of this period.


Shift from open-ended to close-ended
Presently, there are more than 180 open-ended equity funds and a modest 22 close-ended equity funds. The question that will come to mind is – up to now, mutual funds seem to prefer offering open-ended funds, so why the recent spate of close-ended funds? The answer to your question lies in the recent change in regulations. Open-ended funds could earlier write off expenses incurred to launch the fund over a period of years. This was disadvantageous to investors who stayed invested in the fund over a long term since investors who exited earlier did not bear their share of the cost. Now, SEBI has stated that these expenses should be paid by the new fund investor in the form of an entry load. However, for close-ended funds, these expenses can be written off against the fund over the life of the fund. So, if a new close-ended fund is a 3-year fund, these expenses can be written off over 3 years. This makes it easier for mutual funds to market funds since levying an entry load in a new fund offering is a disincentive to investors.

Benefits of close-ended schemes
Investing in close-ended equity funds is preferable to open-ended ones because of 2 reasons: firstly, the fund manager can take investment decisions with a long-term view since he does not have to worry too much about redemptions (usually close-ended funds levy high exit loads for redemptions done before completion of fund tenure, thereby discouraging investors from redeeming prematurely) and secondly, the entire corpus of the fund can be fully invested, thereby making every rupee work to earn returns. Past comparison of closed versus open While conceptually, investing in a close-ended fund makes more sense than investing in an open-ended one, factually, the past tells a different story. Taking 1-month, 3-month, 6-month and 1 year performances, as on 30 November 2006 for growth options of close-ended and open-ended diversified equity schemes, in almost all time periods, performances of open-ended schemes have been better.


To conclude
Before making an investment decision, consider parameters and aspects that help you believe that the investment option is worth putting your money in. Where mutual fund investing is concerned, it is always preferable to invest in an existing scheme with a proven past track record of consistently good performance. This is where close-ended schemes fail since you cannot invest in them once their initial offering closes. Investing during the initial offering means putting your money into a scheme without a past performance track record. - Recently, a number of schemes have been launched as close-ended schemes for a specific tenure after which they become open-ended - While conceptually, investing in a close-ended fund makes more sense, factually, the past tells a different story. - It is always preferable to invest in an existing scheme with a proven past track record of consistently good performance. - This is where close-ended schemes fail since you cannot invest in them once their initial offering closes.