What is the Closed-End Fund?
A closed-end fund is a type of professionally managed fund having a defined portfolio (the combination of more than one script) based on a fixed number of shares issued at an initial public offering, listed on the exchange for trading in the secondary market and are not redeemable from the funds.
- These are professionally managed funds the same as a mutual fund. They have a dedicated relationship manager who takes care of the portfolio and carries on trading constantly i.e. buying/selling and/or holding of scripts as per the market conditions.
- Same as exchange-traded funds, these are traded as equity as their prices keep on changing throughout the trading session. Although these are very similar to equity traded funds but have a huge difference also.
- After initial public offering, under closed-ended funds, the company cannot issue further shares. Also, these funds cannot be redeemed by way of buyback of shares. The only thing possible is buying and selling these shares in the secondary market by investors.
How does it Work?
- They have several features that make it popular among its class. These are similar to exchange-traded funds or mutual funds. These funds are maintained by investment advisors which are run by expert management who initiates trading on a set portfolio.
- They charge some fees which in turn yield revenue to investors in the form of capital gain. This is categorized as an investment company that is accessible by the general public for investing.
- Both the portfolio and portfolio manager needs to be registered with securities and exchange commission and comply with exchange guidelines/requirements.
- As per the rules of security exchange commission, it can be launched only by way of initial public offering open for a short period (2-10 days) as allowed by exchange rules, as allowed.
- Afterward, these funds are treated as shares and are traded in the stock market as equity scripts. The price of the fund can be more or less than the initial public offering price depending on the demand and supply in the market.
Closed-End Funds Example
- HDFC Equity Opportunities Fund – It’s a large-cap closed-end fund maturing in July 2020 corpus of 1118 crore traded at 9.85 against 10.65 NAV with an 8.1% discount.
- ICICI Prudential Value Fund – It is a valuable fund with assets of 1779 crore attaining maturity in June 2021 traded at 9.2 against 10.38 NAV with a 12.8% discount.
- Units of ICICI Prudential Bharat Consumption Fund – It is a series II fund with assets of 267 crores traded at 8.79 against 9.91 NAV with a 12.9% discount.
How to Invest in the Closed-End Fund?
- Investment in closed-end funds can be done directly in markets or through agents and can also be done by contacting mutual fund distributors and asking them necessary formalities and forms and applications which need to be completed. Before investing, an investor must ensure that he is investing through distributer registered with the association of mutual fund which deals in such fund having ARN number allotted by association.
- If investment needs to be made through a direct plan, then a financial advisor is required which is available through distributors, but there is no need to pay any commission to the distributor for the advisory services. Distributer must disclose all the tariffs commissions and charges payable to them for all available schemes.
- The investor can invest directly by visiting closed-end funds, mutual funds branches or through online websites. Physical forms can be submitted to agents and distributors who provide such services.
Before investing, the investor must check the track record of funds and schemes and must also refer to product labeling.
Labeling must contain –
- Nature of scheme
- Investment objective
- Level of risk
- Scheme information documents
- Stability – These are stable with their asset base. At the time of NFO, these funds gather a huge asset base. The fund manager is at minimal risk of asset redemption and the occurrence of the change in the asset. These funds can be invested in other financial assets, equity or debt securities.
- New Opportunities – It allows investors to invest in a wide range of new and creative strategies.
- Freedom from Large Flows – There is no risk of huge inflows and outflows in closed-end funds. Investor money is locked until the time of maturity as a result fund manager is capable of making rational decisions.
- Enhanced Flexibility – Investor is free to sell the fund and liquidate his position as per rules made by the fund house. These units can be sold in the market during trade hours.
- Unique Portfolio – A unique portfolio can be created by the fund managers in order to earn better returns.
- Trading on Stock Exchanges – Investors are allowed to trade units of their closed-end fund on a stock exchange, prices may vary from the net asset value of funds.
- Cost – Subscriber has to pay heavy fees on buying or selling unit,
- Subscribing Option – Can be bought only through brokers or intermediaries.
- Prompt Changes – Portfolio under such funds are subjected to rapid changes that are usually unpredictable.
- Liquidity – These funds offer less liquidity as compared to open-end funds.
- Pricing – Discounting factors may lower the price of the closed-ended funds.
- This can be described as a type of professionally managed fund containing a fixed proportion of scripts within itself (a defined portfolio) offered during the initial public offering and cannot be redeemed from the funds but can only be traded in secondary markets.
- This funds offer wide benefits like providing stability, flexibility, fixed non-redeemable funds, unique portfolio, and exchange trading options but also have shortcomings like locking of funds which cannot be redeemed from funds (one can get out by trading on the secondary market), cost of subscribing is more as certain fees need to be paid to portfolio managers, the unpredictability of markets, limitations in subscribing options.
This has been a guide What is the Closed-End Fund & its Definition. Here we discuss how to invest in closed-end funds and how does it work along with examples and differences from open-end funds. You can learn more about from the following articles –