Close-ended funds can prove to be interesting propositions in the context of both equity and debt-oriented funds. In a debt fund, the fund manager can make investments in line with the fund’s tenure and on maturity offer returns with a reasonable degree of certainty. Similarly, equities are known to be the best-performing asset class in comparison with peers like gold, property and bonds among others over longer time frames (i.e. over 5 years). Though, the key lies in staying invested for the long haul. The fund manager of a close-ended equity fund can make investment decisions with a long-term perspective and be indifferent to short-term occurrences. This is in contrast to open-ended funds wherein the fund’s performance is constantly under scrutiny thereby forcing the fund manager to react to near-term events.
Another area, where close-ended funds score over open-ended funds is liquidity management. In an open-ended fund, the fund manager has to cope with monetary inflows-outflows on a continuous basis. The same could hinder his investments and the fund’s performance as well. For example, a fund may witness huge inflows when equity markets soar; in such a scenario the fund manager may not be able to identify enough investment opportunities to allocate money. This could result in a portfolio which is not in sync with what the fund manager actually wants to do. In contrast, a fund manager in a close-ended fund is aware of the corpus at his disposal and also the tenure for which it has been made available to him. The same can grant a degree of stability to the fund management process.
Close-ended funds can aid investors’ cause by granting defined investment tenure to their investments. The same can help investors in their financial planning process. Investors can provide for their needs/goals by investing in close-ended funds with a matching tenure. This instills a degree of discipline in the investment process because the investor is unlikely to withdraw the money unless there is an urgent need. With open-ended funds, the temptation to do that is very strong.
In the event of a change in the fundamental attribute of the scheme/fund house investors in close-ended funds have an exit option just like their counterparts in open-ended funds. For example, if the fund house is going to merge into another, investors in close-ended funds have the option of either becoming a part of the new entity or simply liquidating their investments.
On the flipside, investing in a close-ended fund entails necessarily participating in an NFO every time. As a result investors have no track record or performance history for evaluating the fund. Ideally a fund’s performance across a market cycle (Bull Run and bear phase) and on parameters like Standard Deviation and Sharpe Ratio must be evaluated before making an investment decision. Instead while investing in an NFO, investors have to rely on the fund house and its investment practices/processes for making the investment decision.
Critics argue that the fund house’s motivation while managing a close-ended fund is put to test. Having garnered all the monies the fund could during the NFO stage, even a superlative performance by the fund can’t help the fund house augment its assets under management by way of fresh inflows. We believe such an argument doesn’t hold good. If a fund house was to behave in the said manner, its impact would be evident in the corpus accumulated by the fund house in its future offerings.
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