The pros and cons of closed-ended MFs

These offer investing flexibility but you can't redeem easily before their tenure ends

As closed-ended fund managers don’t have to worry about redemption pressures, they can buy good undervalued stocks that may have low liquidity. However, you might not be able to get your money back before the tenure ends, as these aren’t that liquid. Now, closed-ended equity mutual funds, popular a few years ago, seem to be ready to make a comeback. While ICICI Prudential Mutual, Union KBC Mutual and Axis Mutual Fund have launched closed-ended schemes in the last couple of months, Reliance Mutual Fund also launched one recently. ICICI Prudential’s Value Fund Series-I, a three-year closed-end fund for which subscriptions closed recently, got Rs 643 crore.

“If the fund house has a good track record, people can invest,” says Feroze Azeez, head (investment products), Anand Rathi Private Wealth Management. “Personally, I am not in favour of closed-ended funds because these don’t let you exit at the peak net asset value.”

Structurally, closed-ended funds can take concentrated portfolio bets and invest in only a few stocks, about 25-30. That can be an advantage, as it can give you better returns. On the other hand, an open-ended fund usually has a large number of scrips that are liquid and in the large-cap segments to keep a buffer for redemption pressures.

In an open-ended fund, you can enter (invest), and exit (redeem) your units any time. But in a closed-ended fund, you can invest only when it is open for investment — during the period of the new fund offering. And, you cannot redeem your units before the closed-ended period is over. The only way to exit is by selling these on the stock exchange, though this is often at a discount to its net asset value.

Since equity investment requires time, a closed-ended fund ensures investors remain committed to the investment for a certain period. This is positive, says Hemant Rustagi, chief executive of Wiseinvest Advisors. But these may not compare well with open-ended funds. “Historically, open-ended funds have done well. Overall, these are more flexible. So, if investors are disciplined and don’t panic and rush to redeem investments when markets fall, it is as good as investing in a closed-ended fund,” Rustagi says.

Returns from closed-ended funds could be higher because of their concentrated bets and the themes these invest in. “A value theme or a contra-theme, both long-term, take time to fructify,” says Dhruva Raj Chatterji, senior investment consultant with Investment Management. “But the fact remains there is no tangible benefit to investors in closed-ended funds, and open-end funds will do just as well,” he says. “Since liquidity is an issue in closed-ended funds, one should invest only if he/she is sure those funds will not be required for the duration for which these are invested, say, three or five years.”

Distributors have been selling these funds because these funds can pay higher commissions. But investors shouldn’t be lured to these funds simply because their distributors recommend those. Instead, look at the investment philosophy and whether you can stay invested in the fund for its entire lock-in. Also, consider whether the investing philosophy complements your existing portfolio.