Closed Ended Mutual Funds Escape Outflow Pressure

Lock-in period ensures long-term gains by deterring premature exit

There has been a proliferation of closed-ended funds in India of late. With the market showing strong signs of moving northward for a longer duration, a number of fund houses have launched schemes that will not take in new investors after the new fund offer (NFO) period ends.While these funds are listed on the bourses, trades in these units are infrequent and, so, liquidity is low.

Closed-ended funds belong to a category of mutual fund schemes where, following the closure of the NFO, a fixed number of units of the scheme are issued to investors and are listed on the bourses.

After the NFO, the fund manager takes between three and six months to build the portfolio of the scheme and then manages it actively till the maturity of the scheme, which is decided even before the launch of the scheme.

mutual fundsA key difference

These funds differ from openended funds in one key aspect.In closed-ended schemes, since new investors are not allowed to come in like in open-ended schemes, the fund manager does not face the task of managing cash flows on a regular basis. That is, heshe does not have to think of where to invest the money as soon as new investors come in.Nor does heshe need to think of which stocks from the fund’s portfolio to sell to meet redemption pressures.

Often, it is seen that in an open-ended fund, the fund manager is forced to sell off some of the stocks from the fund portfolio to meet redemption pressure even if heshe believes that the stock was not held for the optimum time and was yet to appreciate to its potential. In closedended funds, since there is no option of any redemption midway through the schemes’ life, the fund manager has the leeway to hold on to the portfolio of stocks the way heshe thinks is the best for the scheme’s investors.

Most have 3-year lock-in

In India, most closed-ended funds are of three years duration. Post that, either the schemes return money to investors or the scheme is converted into an open-ended one. It has been observed that investors become jittery if the fund remains closed for more than three years and, so, they don’t want to invest in schemes of more than threeyear duration, according to industry officials.

Although these units are listed on the bourses, which is a regulatory requirement, investors usually do not sell since units trade at a substantial discount to the fund’s net asset value (NAV). Seen from the side of the buyers, they can get an asset at a discount to its actual value.

Another unique characteristic of closed-ended funds is that, in case of any panic selling in the market, while open-ended funds may face strong redemption pressure, closed-ended funds face no such outflow pressure. In the present situation, given the strong fund flows into the market and the current bull run, investors who are putting money in these funds are expected to gain when these schemes mature, financial advisers say.

Things to keep in mind

Financial planners also point out that while investing in these funds, investors need to keep in mind three things. One, they should consider the duration of the scheme and their willingness to keep their money parked in the scheme for that exact duration.

Then they should also look at the theme of the closed-ended funds and if their individual risk profile matches with the kind of risk the fund will be subjected to. They should invest only if these two match. Investors have the right to know the theme of the schemes -it could be a large-cap, mid-cap, small-cap, sector-specific, economic or financial theme-specific, etc -and then take an informed decision on the fund.

Also, they should look at the track record of the fund house and the fund manager to manage such funds.