Rome wasn’t built in a day! It took years and years of toil to create the well-renowned masterpiece. We all know that patience is key to building anything great and worthwhile. The same axiom holds true for building your mutual funds portfolio.
Open-ended funds and closed-ended funds are the two most important categories of mutual funds. The popularity of open-ended mutual funds among Indian investors is well known. Closed-ended funds, too, are fast picking up steam. If you have ignored the niche world of closed-end funds until now, please think again!
Do you want to know what is close ended mutual fund is and how they work? To begin with, these close ended mutual fund India put your wealth to work only for a fixed amount of time to help you ward off the ephemeral day-to-day volatilities of the capital market and earn handsome returns over a longer time. This article will explore how going for these funds can offer you the right competitive advantage over other investors. Without waiting any further, let’s get started.
What is Close Ended Mutual Fund?
Close Ended Mutual Fund Meaning
As the name suggests, close ended mutual funds have a well-defined lifetime; that is, the period between the new fund offer (subscription) and maturity is already fixed at the time of the fund issue.
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Quite different from the popular open-ended mutual funds that allow continuous subscriptions and redemptions, once you miss the bus on these close ended funds, you miss it altogether. You only get a fixed time window to make up your mind.
This time window is technically known as the NFO period. The term NFO stands for New Fund Offer. It offers the required time to carry out all due diligence and research analysis before purchasing the desired units of the close ended new fund. Its examples include closed end mutual funds and new fund offers.
Are NFOs close ended Mutual Funds?
The straightforward one-word answer to this question is No! NFOs can be both open end funds and closed end funds. NFOs are among the most popular categories of mutual funds in India. Let us understand more details about NFOs.
The first important detail you must know is the NFO’s duration. As per the latest circular issued by SEBI on mutual funds in India, you are only given 15 days to decide. This time is usually sufficient enough to learn all the important details about the concerned NFO.
If you already know about the technical terms of finance, you could read the NFO’s offer document for yourself. Otherwise, you could seek professional expertise offered for free on reputed digital platforms.
As per the guidelines issued by SEBI for mutual funds, fund houses are required to publish the offer document. Acting as a preamble to the new fund on offer, this document informs investors about the investment objectives, asset allocation strategy, performance benchmarks, and maturity period.
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Did you know that there is a minimum investment threshold that an NFO must raise? Currently, this limit is twenty crores for debt-oriented and balanced hybrid schemes. For other mutual funds, it is ten crores. If a particular issue fails to garner this minimum target, the NFO is cancelled, and the fund house must refund the application amount to the investors.
SEBI guidelines state that a fund house can start investing the offer’s proceeds only after the completion of the entire subscription period. The most important feature of a close-ended NFO is that further investments are impermissible after the completion of the NFO’s subscription period. This provides stability for the fund manager to focus on the existing investment strategy only.
Types of Close Ended Mutual Funds
Let us look at the types of close ended mutual funds offered in India, a category known popularly as close ended mutual fund India.
1. Equity Schemes
Equity schemes invest their sums in equity instruments. Close ended equity funds invest in a concentrated basket of stocks across market capitalisations and sectors, but the portfolio strategy is focused on attaining the maturity milestone.
While some categories of funds target undervalued stocks over 3-5 years for long-term gains, some sectoral funds aim to benefit from high-growth industries over their rewarding business cycles.
2. Debt Schemes
Debt-based close ended mutual funds take concentrated exposure to debt instruments with longer maturities. Fund houses investing in such schemes decide on investment instruments with a relatively lower risk profile.
There are two basic types of debt schemes: Fixed maturity plans that are aligned with scheme’s maturity and debt plus capital protection plans that invest partially in equities also to boost the overall returns.
3. Hybrid Schemes
Hybrid funds tend to adhere to a fixed allocation combination for equity and debt instruments made at the time of their creation to maintain the overall risk-return characteristics expected at maturity.
In this regard, most hybrid closed-end funds invest around three-fourths of the funds received at the time of fund formation in debt securities of similar maturities to provide stability and offset the fluctuation expected from the remaining equity part.
In summary, depending on your investment preferences, you could select any of India’s three types of close ended mutual funds. Most importantly, selecting tax savings funds from these categories (with a 3-year lock-in period) can help you bypass the capital gains tax rules.
Key Features and Benefits
Let us look at the key features and benefits of close ended mutual funds.
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1. Market Price Determination
The price of the close ended mutual funds is decided by the forces of demand and supply of the secondary market. The trading price of fund units usually differs from the net asset value. The possibilities of trading at a premium or a discount to the NAV attracts investors.
2. Limited Liquidity
Close ended funds offer limited liquidity compared to their open-ended counterparts. You can trade the units held only on the secondary market, subject to market demand.
3. Market Trading
You can trade the units of your close ended mutual funds like individual stocks. You can buy or sell these units at the price prevailing in the market. Please note that this price usually differs from the net asset value.
4. Fixed Tenure
The tenure of a close ended mutual fund is predetermined. You must check this tenure in the offer document before purchasing your scheme. After this fixed tenure, the investors receive their returns based on the number of units they hold in the fund.
Conclusion
Close-ended mutual funds offer a great choice for investors prioritising portfolio stability and gains through market pricing mechanisms. With a fixed tenure of maturity, these close-ended mutual funds can protect you from ephemeral market volatility. Amid the uncertain times that we are currently living in, purchasing close-ended mutual funds could be a step in the right direction for future financial security.
FAQs
1. What are closed ended mutual funds?
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Closed ended mutual funds are the funds that raise a fixed amount of capital by issuing the fund units only during the New Fund Offering (NFO) period. The fund is then closed for regular subscriptions.
2. What is the minimum investment and lock-in period?
The minimum investment is ₹5,000 per application. The lock-in period is 5-7 years from date of allotment of units. Investors can exit only when the fund matures.
3. How are these funds taxed?
The taxation of closed-ended equity funds is similar to that of open-ended equity funds. Only long-term capital gains above ₹1.25 lakh per year are taxed at 12.5%, while short-term gains according to Section 111A for 20%.
4. Who should invest in closed ended mutual funds?
These funds suit informed investors looking for a disciplined and planned approach to investing for defined goals like retirement planning and for funding the education of children.
References:
https://groww.in/p/closed-ended-funds
https://www.bajajfinserv.in/investments/decoding-close-ended-mutual-funds
https://www.geeksforgeeks.org/closed-ended-mutual-funds-meaning-features-suitability/
https://www.5paisa.com/stock-market-guide/mutual-funds/closed-end-mutual-fund
