What Are Close Ended Mutual Funds? 

A close ended mutual fund (CEF) is a type of mutual fund scheme with a stipulated maturity period. Unlike open-ended funds, which are available for subscription and redemption continuously, CEFs are only available for purchase during their initial launch period, known as the New Fund Offer (NFO). This structure effectively locks in the investors' capital until the scheme reaches its maturity date, which helps to define closed end mutual fund schemes by their fixed lifecycle. Once the NFO closes, new units cannot be created, and existing units cannot be directly redeemed with the fund house before maturity.

How Do Close-Ended Mutual Funds Work? 

The operation of a close ended mutual fund is straightforward. An Asset Management Company (AMC) launches the scheme for a specific duration (e.g., three to five years). Investors buy units during this limited NFO period. Once the NFO ends, the fund size is fixed. Because investors cannot redeem their units with the fund house before maturity, the fund manager is relieved of the pressure of maintaining high liquidity. For investors who need to exit before maturity, the fund is typically mandated to be listed on a stock exchange. This listing allows existing shareholders to sell their units to other investors, similar to trading a stock. At the final maturity date, the fund is dissolved, and the value of the underlying assets (Net Asset Value or NAV) is returned to all shareholders.

Key Features of Close-Ended Mutual Funds 

Here are the key characteristics that differentiate CEFs from their open-ended counterparts:

• Fixed Maturity Period: Every closed end fund MF has a defined maturity, often ranging from three to five years.
• Limited Entry: Units can only be purchased during the initial NFO period.
• No Direct Redemption: You cannot redeem units with the AMC until the maturity date.
• Exchange Trading: Units are typically listed on stock exchanges, offering an alternate exit route.
• Lump-Sum Investment: CEFs are typically designed for lump-sum investments and do not offer Systematic Investment Plans (SIPs).

Advantages of Investing in Close-Ended Mutual Funds 

Investing in a close ended mutual fund offers distinct benefits, particularly for the fund manager and long-term investors:

1. Portfolio Stability: Since the capital base is stable (locked-in), the fund manager doesn't have to worry about sudden, massive redemptions. This stability allows the manager to implement a more consistent, long-term investment strategy, focusing on high-conviction ideas without being forced to sell assets prematurely to meet investor exit demands.
2. Potential for Unique Strategies: The certainty of the investment horizon enables fund managers to explore less liquid, potentially undervalued debt and equity securities. These instruments might not be suitable for open-ended funds that require constant liquidity. This access to unique opportunities may increase the probability of superior long-term returns.
3. Harnessing Discounts: Units of a closed end mutual fund schemes often trade on the stock exchange at a discount to their underlying NAV. Investors who purchase units at a significant discount have the potential to earn extra returns if the discount narrows over time or when the fund matures and pays out the full NAV.

Types of Close-Ended Mutual Funds

Just like open-ended funds, close ended mutual fund schemes are classified based on the assets they invest in:

Tips for Choosing the Right Close-Ended Mutual Fund 

Before you invest, you must perform due diligence, as your capital will be locked in. Here are some tips for choosing a suitable close ended mutual fund:

1. Match Maturity to Goal: Ensure the fund's maturity date perfectly aligns with your financial goal's timeline.
2. Review the Strategy: Carefully read the NFO document to understand the investment strategy and the underlying assets the manager intends to buy.
3. Evaluate the Manager: Look at the fund manager’s track record, especially in managing similar long-term or lock-in schemes.
4. Lump-Sum Comfort: Ensure the lump-sum amount you are investing will not be needed during the lock-in period.

Risks Associated with Close-Ended Mutual Funds 

While CEFs offer stability, they are not without risk. The primary factor is the mandatory lump-sum investment during the NFO, which makes it difficult to average out costs through SIPs. Furthermore, the lock-in period means you lose the flexibility to redeem your money easily. If you are forced to exit early by trading on the exchange, you might have to sell the units at a price discounted to the NAV, potentially crystallizing a loss. Therefore, ensure you have a long investment horizon before opting for this investment route.

Close-Ended vs Open-Ended Mutual Funds 

The fundamental difference lies in liquidity and flexibility:

How to Invest in Close-Ended Mutual Funds? 

Investing in a close ended mutual fund is a straightforward process, provided you act during the NFO window:

1. Complete KYC: Ensure your Know Your Customer (KYC) compliance is completed with the fund house or registrar.
2. Identify NFO: Find an active close ended mutual fund NFO that aligns with your goal and risk profile.
3. Place Order: Fill out the application form (or use the online portal) during the NFO period, specifying the lump-sum amount.
4. Fund Transfer: Transfer the required lump-sum amount to purchase the units.

Remember, after the NFO closes, you cannot enter the scheme unless you purchase units from another investor on the stock exchange.

Conclusion 

Understanding what are close ended mutual funds is key to leveraging their benefits. They provide a compelling option for disciplined, long-term investors seeking to minimize the impact of behavioural mistakes (like premature redemptions) and benefit from the stability afforded to the fund manager. When your investment horizon is fixed and long, a well-chosen close ended mutual fund may enhance the probability of superior returns over its defined lock-in period.

Frequently Asked Questions (FAQs)

Can I redeem a close-ended mutual fund before maturity? 

No, you cannot redeem units with the fund house before maturity. Your only exit option is to sell your units on the stock exchange, which might result in selling at a discount to the NAV.

Are close-ended mutual funds suitable for beginners? 

They can be suitable for beginners with clear, long-term goals who can commit a lump-sum amount, but they require a strong understanding of the lock-in and trading mechanism.

How is NAV calculated in close-ended mutual funds? 

The NAV (Net Asset Value) is calculated daily, based on the market value of the fund's underlying securities. However, the market price at which the fund trades on the exchange can be different (premium or discount) from this NAV.

Do close-ended mutual funds offer dividends? 

Yes, just like open-ended funds, CEFs can offer a Dividend Payout Option, which distributes profits back to investors periodically.

What happens when a close-ended mutual fund reaches maturity? 

When a close ended mutual fund matures, the scheme is dissolved. The fund manager sells all underlying assets, and the resulting cash is distributed to all unit holders at the final prevailing NAV.