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Close Ended Mutual funds
Most equity mutual fund schemes available in the market in India are open ended —you can invest whenever you want and redeem money at will. And investment and redemptions happen at a price very close to the net asset value (NAV) of the fund.
But there is another variety of equity funds called the close-ended schemes, in which you need to stay invested for the duration of the fund, usually three years or more.
Like in open-ended funds, investing in close-ended plans involves risk. Such schemes call for a more discipline approach by the fund manager, industry players said. And since the investor has no chance to redeem investments at will, the fund manager does not have to think about outflows and is not forced to liquidate stocks that could give more returns in another few months of years.
The market is not an accommodating machine. Here, the returns usually come in spurts.
Often, in an open ended fund, to meet investor redemptions the fund manager is forced to sell a stock before its full value is realised in the portfolio. There could be opposing investment approach in an open-ended fund: While the investor wants to exit after some time, the fund manager may be willing to hold on to the stocks for some more time but is forced to exit prematurely. In a close-ended fund, by the very structure of the scheme, the investment horizon of the investor matches exactly with the investment horizon of the fund manager.
In a close-ended fund once the stock hits the targeted price, the fund manager could sell it and return the money to investors in the form of dividend. Alternatively, the manager could reinvest the gains in some other stock(s) that are likely to give returns till the closing date of the scheme.
A close-ended structure could also allow the fund manager to have a concentrated portfolio of stocks, meaning he could invest in just a handful of stocks which he believes could be the winners till the close of fund. Also, unlike in an open-ended fund, in a close-ended scheme only those investors who pump in money at launch get rewards at the close.
Of late, several fund houses in India have been launching close-ended funds to benefit from the emerging opportunities. Fund managers said there were several reasons for this spurt. The stock market seems to be in a very favourable situation for long term investments. For one, there is an unprecedented electoral mandate after the Lok Sabha polls with a single party getting a simple majority after three decades. On the economic parameters, inflation is showing signs of bottoming out with the government and the RBI's measures to control prices —controlling gold imports, administrative steps to tackle food prices and a limited rise in minimum support prices — showing results. Economists say that if the rate of inflation falls, it could lead to easing of the rate of interest in a few months from now. All these could also lead to credit growth, increase EBITDA (earnings before interest, taxes, depreciation and amortisation) margins and also earnings growth for corporates. These positives are sure to lead to a bull rally in the market, fund managers and analysts said.
Most close-ended funds have a three-year tenor. So the fund manager will have these many years to realise the gains from the portfolio of stocks he invests in.
There is an emotional reason also for investing in a close-ended fund, industry officials said.
Fund industry officials also put forward some caveats for investors in close-ended schemes. For one, these schemes are not a substitute but compliment the open ended ones. Also, these funds lack liquidity. Although closed-ended funds are listed on the bourses, but for most part of its tenure these schemes trade at a value which is discounted to their net asset value (NAV). So if an investor wants to exit much before the close of the scheme, he can expect to get much less than the actual value of his investment.
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