So now you have sound knowledge of mutual funds, let’s try to understand some technical terms. Investors have the option to choose between Open Ended Mutual Funds and Close Ended Mutual Funds, while investing in mutual funds.
Understanding the differences, advantages and disadvantages are crucial for making smart investment.
What are Close Ended Mutual Funds?
Close ended mutual funds issues a fixed number of units that are traded on the stock market or in the OTC (over-the-counter) market. Once the total shares are sold, no additional shares are issued.
However, close ended mutual funds are not traded at NAVs and are traded based on the demand and supply and other factors.
Like open ended mutual funds, close ended funds are managed by professional fund managers to fulfill goals and objectives of the fund.
How Close Ended Mutual Funds are issued?
They are launched through an IPO with an objective to raise money and then traded in open market just like a stock.
Pros of Close Ended Mutual Funds:-
- Stability:- In Close Ended funds, investors are not permitted to redeem their investments before the maturity dates. Due to fixed maturity, less fluctuations are noticed. This allows the fund manager to work on long term strategy to maximize returns.
- Trading Data Available:- Since close ended funds are traded in stock market, real time market prices are available (which may be higher or lower of NAVs) for trading.
- Better Return:- They provide better returns as they are issued for long term.
Cons of Close Ended Mutual Funds:-
- High Brokerage:- The brokerage fees charged can be quite high, which reduce the price of the shares whey they are traded.
For eg, if a close ended fund sells 10 lakh shares at Rs. 10 per share and there is a commission of 5%, the fund receives Rs 9.5 cr to invest (Rs. 50 lakh is deducted from the Rs. 10 cr proceeds). The share prices will drop in value from Rs. 10 and will trade at discount.
- No Portfolio when launched:- Close ended funds when launched do not have any portfolio constituted, which leaves the investors guessing.
- Lump Sum Investment required:- Lump sum amount is required to buy the units of the fund at the time of launch. Large no. of investors are not able to invest due to higher amount, since they prefer SIP (systematic investment plan) mode.
- No Previous Track Record:- Close Ended fund do not have any historical data available, which leaves the investors with no performance comparison. Hence, investing in close ended funds invites uncertainties and too much reliance on fund manager performance.
So the bottom line is though close ended funds might produce a better return, combining both return and growth, but still investors needs to be cautious of the cons of close ended funds.