Closed Ended Funds: Five Things To Know Before You Invest Your Money

A close ended fund or closed ended fund is a mutual fund created by issuing a fixed number of units that are not redeemable during the fund's lifespan. A closed-ended fund that raises Rs 500 crore, for instance, for three years will keep the sum invested in financial markets (barring the cash component) without any fresh capital infusion or redemption during the three-year period. However, the fund, divided in small units, can be traded just as a share or the ETF (exchange traded fund). Trading the fund's units on a stock exchange enables investors to buy and sell them in the same way as the shares of a company.

The five things that you should know about the closed-ended fund:

1. Since the money is raised only once, the closed-ended funds don't offer the flexibility of SIP (systematic investment plan) which means you can't invest in the fund in fixed monthly instalments.

2. It is relatively risky when compared to the open-ended fund since the closed-ended fund doesn't have any precedent of past performance to look at.

3. The closed-ended funds are quite illiquid since they don't allow new investors. This is why it is not always easy to find a buyer for the closed-ended securities, and you may end up selling your units for a discount in case you want to exit the fund before the lifespan. "Since these products are close-ended, redemptions are not possible. The only option is to sell this fund is on the exchange, but there is limited or no liquidity typically available on these. Thus for all practical purposes, once invested the fund needs to be held till maturity," said Kaustubh Belapurkar, director fund research, Morningstar Investment Adviser.

4. Closed-ended funds are actively managed mutual funds and the financial advisers have a lot of flexibility in terms of risky or safe bets that they wish to take. "One advantage of investing in close ended funds is that it gives the fund manager the leeway to invest as per the intended strategy and stay fully invested without having to bother about maintaining cash for any redemptions. Thus managers can follow a buy and hold strategy with their high conviction ideas," Mr Belapurkar said.

5. Unlike open-ended funds, closed-ended funds are less prone to volatility. In case of open-ended funds, investors are keen to redeem when exorbitant profits occur (thus bringing the market value down owing to selling pressure), an option not available in case of closed-ended funds.