Closed-Ended Funds - Meaning, How they Work, Advantages & Disadvantages

Gaurav Seth
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Gaurav Seth

Mutual funds are those investment vehicles which pool money from many investors to invest in different market securities like equity, debt, money market instruments, gold, etc. as per the investment objective of the scheme. On the basis of redemption & liquidity, mutual funds have been categorized into two types i.e Open-ended funds & Closed-ended funds.

Open-ended funds are those mutual fund schemes which allow fresh investments & redemptions at any time as per the requirement of investors. These funds are also available for investments after their NFO (New Fund Offer) period. This offers high liquidity to investors on their investments.

What are Closed Ended Mutual Funds?

Closed-ended funds are those mutual fund schemes where investments can only be made during the NFO period of the fund. Investors are not allowed to make any investments after the completion of the NFO period. These funds are launched for a specific tenure or maturity like 3,5 or 7 years after which investments are liquidated and money is returned to investors along with the gains (or losses) on investments. Also, these funds are listed on stock exchanges where the investors can make buy/sell transactions during the tenure of the scheme.

In this article, we will talk about the important features, advantages & disadvantages of closed-ended funds in-depth to understand their investment attributes. Also, we will discuss how they differ from open-ended funds?

How do Closed-ended funds work?

Closed-ended funds are made open for subscription by investors during their NFO period. The NFO period is simply those dates on which a new subscription can be made by investors. After it is over, investors cannot make fresh investments or request for redemptions from the scheme. The units of closed-ended funds are listed on the exchange which allows investors to make any buy/sell transactions at the prevailing market rates. Some mutual funds also offer the facility to repurchase investor's units at NAV rates periodically in order to provide liquidity. As per SEBI mandates, these funds need to offer either of these two options for providing an exit facility to investors i.e repurchase of units or listing on the stock exchange. 

The NAV of such schemes are updated as per the movements in the underlying portfolio. In the case of funds listed on an exchange, their price is also subject to volatility as per the bid & ask prices by investors.

At the time of maturity, the assets of closed-ended funds are liquidated & investors are returned their invested money along with the gains applicable.

Investors can make decisions regarding investments in these funds based on their risk appetite, investment horizon & financial goals. Close-ended funds, like any other investment product, have their own advantages and disadvantages. Let's have a look: 

Advantages & Disadvantages of Closed-Ended Funds

Advantages of Close Ended Funds

  • Provides a disciplined investment approach

A fixed maturity of the mutual fund scheme presents a disciplinary approach to investing as units are held till maturity. This helps to generate capital appreciation & grow your money over a period of time.

  • Fund Management

The fund manager in closed-ended funds can show their fund management expertise & deliver a good performance over the period because they will not have to face redemption pressure or liquidity issues in these funds.

  • AUM Stability 

The assets in closed-ended funds remain stable after the NFO period is over & till the maturity of the scheme. This helps to generate better returns for investors as the fund manager would not have to rely on selling holdings for meeting redemptions.

Disadvantages of Closed-Ended Funds

  • Low Liquidity

There is very low liquidity in closed-ended funds. Investors are not allowed to make redemptions before maturity. Although, these funds are listed on an exchange but generally liquidity remains very low. Also, investors might have to sell units at discount to their NAV value sometimes.

  • No Track record

There is no performance track record for closed-ended funds. As these funds are closed after a specific period of maturity, investors do not have any data of past performance at the time of NFO launch.

  • Fixed maturity limits returns

Equity securities have the potential to generate extraordinary returns over the very long term. The fixed maturity in closed-ended funds breaks the idea of a very long-term investment as units are redeemed at the fixed maturity of the fund i.e after 5,7 years. This limits the potentially higher returns which can be made if units are held for longer periods.

  • Unavailability of Systematic plans

Closed-ended funds do not offer the facilities of Systematic Investment Plan (SIP), Systematic Transfer Plan (STP), or Systematic Withdrawal Plan (SWP) which helps to manage your finances well by following a systematic approach.

Also, investors cannot benefit from the concept of Rupee Cost Averaging which helps to average out the cost of units by investments via SIP.

Comparison between Open-Ended Funds & Closed-Ended Funds

1. Investment

In Open-Ended Funds, Investments are allowed both during the NFO & after the completion of the NFO period. Whereas in the case of closed-ended funds, investments are only allowed during the NFO period.

2. Redemptions

Investors can redeem their MF units at any time in case of open-ended funds. Whereas, redemptions are not allowed till maturity in closed-ended funds.

3. Liquidity

There's a very high liquidity in open-ended funds as investors are allowed to make fresh investments or redemptions at any time as per their requirements.

Although, closed-ended funds' units are listed on the exchange to offer liquidity to investors but generally liquidity remains very low.

4. AUM

The AUM of open-ended funds keeps on changing with the ongoing fresh investments or redemptions from the fund. In the case of closed-ended funds, the AUM remains the same during the whole tenure of the fund.

5. Modes of Investment

Generally, Investments can be made via both Lump-sum or SIP in case of open-ended funds.

Whereas, Investments can only be made via Lump-sum mode at the time of NFO in closed-ended funds.

6. Investment Requirements

The minimum amount required to invest in open ended funds is generally low as compared to the minimum investment requirements in closed ended funds. 

7. Maturity

The open-ended funds do not have any fixed maturity for the scheme. In contrast, the closed-ended funds have a fixed maturity for the schemes.

Basis Open-ended fundsClosed-ended funds
1. InvestmentFresh investments are allowed even after the completion of the NFO period.Investments can only be made during the NFO period.
2. RedemptionsRedemptions can be made at any time as per the investor's requirements except for ELSS funds which have a lock-in period of 3 years.Redemption is only allowed at the maturity of the scheme. Although, units are listed on an exchange but generally liquidity is very low.
3. LiquidityHighLow
4. AUMAUM keeps on changing with fresh investments or redemptions in the fund.AUM remains the same during the tenure. 
5. Modes of InvestmentSIP & Lump-sum, both are allowed.^Lump-sum investment only during the NFO is allowed.
6. Investment RequirementsHave low minimum investment requirements. Investors can start with SIPs of as low as Rs.100.High minimum investment requirements.
7. MaturityNo maturity period.Fixed maturity period.

^Some open-ended funds might close the facility of a lump-sum investment as per market conditions.

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