Should you invest in close-ended mutual funds?

Manikaran Singal

With stock markets going through bullish sentiments, product manufacturers are coming up with many products to take advantage of such a phase. Even investors do not want to lose such an opportunity and want to have exposure into all such products which claim to generate good returns as they had delivered in the past.

Decision-making factor

Of course past performance is not an indicator of future returns, but this is the one that is most visible to investors and thus become the most important decision-making factor.

New Fund Offer period

One of such products or I should say a structure which are more visible in the rising market scenario are the equity close-ended mutual funds. For the readers who do not understand these funds, let me put in short that close-ended mutual funds are those which can be invested in only during the New Fund Offer period, and can be exited only after the completion of specific period which usually is three years or five years. The opposite of this is open-ended funds which can be invested and redeemed on any working day.

Since close end structure does not allow fund house to accept money after the closing of initial offer, so they keep coming up with different series of same fund to collect more money.

But does this structure suit the investors and if yes, then what kind of investors should invest in such products?

Better returns

Asset management companies claim close-ended funds have more potential to deliver better returns, since in this structure fund manager can take risky calls to get high returns, as they know the certain quantum of money in hand to invest with no undue pressure of redemption by investors.

Rebalancing of asset allocation restricted

On the face of it, it looks right. But there is another side to it too, as this structure does not allow new investments to come in, so in the case of falling market scenario, neither the investor nor the fund house would be in a position to invest more to average out the cost. And thus the presence of these funds in one’s portfolio restricts the rebalancing of overall asset allocation.

Just like rising market, the opposite is also a reality and one cannot deny that. This is what was experienced in the year 2008 when stock markets worldwide fell like stack of cards and investors of close-ended funds found them stuck.

Besides this, what if the fund manager because of which you have got into this fund house, leaves during your investment period? You would have no choice but to stay put.

Redemption rules

Though there is a provision to redeem your holdings on stock exchange as all close-ended funds have to be compulsorily listed, it has been experienced that there is not much demand of these funds over stock market. With high cost structure due to New Fund Offer, stable asset base due to restrictions on exiting, AMCs and the distributor definitely earns more by selling you the close-ended funds, but will you earn out of it or not that is something you have to see and thus should have a definite investment plan at place before you decide to get into this structure.

Look beyond returns

Investment returns wise, I don’t see much attraction in close-ended structure. Returns are something that you can get from open-ended funds too and that too with a much flexible approach. You can have tactical investment calls, you can make systematic purchases, you may book profit or shift to debt to rebalance the portfolio and all this on lesser cost which expectedly further improve the investment returns.

So you need to look beyond the returns, if at all you want to invest in close-ended mutual funds.

Keep emergency fund

You have to have basics at place, like having an emergency fund, required insurances and necessary liquidity in financial investments. 

I have seen many investment portfolios comprising PPF, EPF, ELSS, insurance policies and close-ended mutual funds. All these instruments are illiquid ones, so in case of any major emergency you may get stuck with all these.

Risk tolerance level

Besides all the above, you should understand your risk tolerance level and investment behaviour. Are you a new entrant into stock market and have come here or brought here under the lure of high returns only? 

How much of market fall you would be able to absorb and tolerate, looking at your investment structure and long/short-term goals. Investment planning is a serious business. 

You should be thoughtful enough while putting your hard-earned money. Close-ended mutual funds are not bad, but one should look at both sides of the coin before deciding what may be beneficial for him.

The writer is CFP and SEBI registered Investment Adviser and runs a personal financial planning firm Good Moneying. The views expressed in this article are his own