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Things To Remember Before Investing in Closed-End Funds

IndianMoney.com Research Team | Posted On Wednesday, January 08,2020, 03:02 PM

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Things To Remember Before Investing in Closed-End Funds

 

 

Before we get into the details of investing in a closed-end fund, also known as a closed-end mutual fund or closed-end investment, let us take a quick look at what is a closed-end fund. Closed-end funds are professionally managed portfolios, which consist of a pool of assets.

It raises a fixed amount of capital through an NFO (New Fund Offer) and gets listed on the stock exchange. Further, the trading takes place on the secondary market just like mutual funds.

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Things To Remember Before Investing in Closed-End Funds

When you are investing in a closed-end fund, there are certain key points to be considered.

Absence of Past Records and Real-Time Comparison: Unlike open-ended mutual funds, it is not possible to track the past performance of a closed-end fund. This is because closed-end funds are offered with a New Fund Offer (NFO) that has no past records. These are not open to investors, after the initial offer period. Real-time tracking is also not possible. This lack of past records makes it difficult to review the past performance of a fund and make the judgment call. Another common way to examine a fund is to compare it with peers, which again is not possible in the case of a closed-end fund. Without past or real-time data, the comparison would be tough.

See Also: How Mutual Funds Work?

So How Will you Take an Investment Decision Regarding a Closed-End Mutual Fund?

As all these funds are managed by professional fund managers, the past experience and performance of these fund managers can be considered as a decision making criteria.

Low Liquidity: If you want to invest in highly liquid investments, then closed-end funds are not your cup of tea. They have low liquidity. These funds cannot be redeemed before maturity if the need arises. The only option available would be to sell the units on the stock exchange.

Concentrated Portfolios: Because of the closed structure, fund managers have the opportunity to invest in equities that yield higher returns. Hence they tend to maintain a concentrated portfolio. But when portfolio size decreases; the expense ratio increases. The expense ratio is the fee charged by mutual funds to professionally manage the funds of the investors. This includes administration costs, legal costs, advertising costs and much more. Closed-end mutual funds invest in a few funds and have a high expense ratio.

Lack of SIP option: SIP stands for a systematic investment plan. Most mutual funds encourage systematic investing, where you are supposed to invest a fixed amount at regular intervals of time. Salaried employees are most likely to opt for SIPs.

See Also: Which Type of Mutual Fund Is Best to Invest?

Advantages of Investing in Closed-End Funds:

  • Funds with Differentiated Income or Objectives: An important feature of closed-end funds are, investors will have the opportunity to choose funds with differentiated objectives as well as income, which may not be available in an open market scheme.
  • Time Constraint: As closed-end funds have a specified term, you do not have to panic and sell based on market dynamics. Maturity can be for 3 years, 5 years and so on. This gives the fund managers the option to strategically take decisions regarding fund management. They are not pressurized during the fund period by the investors.
  • Dividend Reinvestment Plans: This means more units without additional costs unlike the case of purchasing more shares in the open market.

See Also: Everything You Need To Know About Mutual Funds

How Much to Invest in Closed-Ended Funds?

An investor can allocate up to 5-10% of their investment towards closed-ended funds. Instead of opting for a single scheme, they can spread their investments across schemes. This reduces risk. 

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