If you prefer doing lump-sum investments and are absolutely sure about not redeeming before maturity, you could look at close-ended funds.
Taking advantage of market sentiment which remained positive for most of the period, fund houses came up with sizeable new close-ended schemes to attract investors. We had about 16 new equity close-ended mutual fund schemes open for subscription from December 2017 to March 2018. Anil Rego, CEO and Founder of financial advisory firm, Right Horizons says, “A certain category of investors seems to be lapping up close-ended funds. We do not believe the launch of close-ended funds will dry up in near term, unless markets go for a sustained correction.”
Abhinav Angirish, Founder of investonline.in adds, “Due to constraint for open ended schemes followed by standard categorisation from SEBI, it is highly possible that AMCs will choose the close ended path to garner fresh funds in this new financial year.”
Let us look at 6 points that an investor should be careful of while choosing to invest in these funds.
What if a 5-year close ended fund continues to underperform the markets/benchmark? Shouldn’t the investor have the option to re-balance his portfolio or exit from the fund? Angirish says, “Though most close ended funds are listed on Nifty, they are very thinly traded for one to exit.”
Dinesh Rohira, CEO, 5nance.com cautions, “Despite being listed on stock exchange, it is least traded and often investor have to sell on discount to NAV.”
2. Portfolio may be liquidated with losses on maturity dateKaustubh Belapurkar, Director Manager Research, Morningstar explains, “Since the maturity date is fixed, irrespective of the market movement, the fund manager will need to liquidate his stock positions and return the money to investors (unless he/she gets a specific approval to rollover/extend the maturity of the fund).” This may result in the portfolio being liquidated in bearish markets with losses on maturity. (Refer to table to review performance of close ended schemes against benchmark which matured in last week of March 2018.)
Close-ended schemes that mirror investment objectives of open ended schemes (such as small cap, large cap, mid cap, etc.) are generally launched with one objective -- to maximise the income of the distributor and the AMCs. Kunal Bajaj, Founder & CEO, Clearfunds utters, “As the investor is locked into these investments, it means larger, guaranteed commissions for the distributor (generally paid upfront) and certainly of fund management fees over the term of the scheme.” So, often there are recommendations to subscribe by distributors in this close ended funds without analysing your risk appetite and financial goals.4. Lack of liquidity
There is no short-term liquidity available in close ended funds. Investors can’t redeem even if there is a sudden requirement of funds. This fund is not suitable for the investors who want interim redemptions during the investment term due to its lock-in terms.
5. No track record of the fund and restricts wealth creationClose-ended funds are launched with NFOs which don’t have any track record to review past performance and scrutinise investment portfolio. The objective of close-ended NFO is aimed to grow AUM and ignore market valuation. Investor gets stuck with fund even if the performance is poor. Rohira says, “Close ended schemes don’t allow regular investments like open-ended schemes which restricts investor to build the wealth for future goals. Also, due to its limited investment term say 3/5/7 years it blocks capital appreciation beyond a duration.”
6. Concentrated portfolio and higher expense ratioClose-ended funds usually have higher expense ratio of 0.5-1.5 per cent more than open-ended schemes. Also, it usually takes concentrated portfolio bets with only about 25-30 stock which can turn risky if you are conservative investor.
Final word
If you prefer doing lump-sum investments and are absolutely sure about not redeeming before maturity, you could look at close-ended funds. Anil Rego advices, “While investing you must understand what kind of filters will be used to arrive at the investible universe, kind of stocks / sectors fund manager will enter, kind of stock-specific limits, cash strategy and investment style of the fund manager in this scheme. If you find comfort only then you may consider to invest.”