Close-ended funds are a unique type of investment vehicle that offers a different approach to portfolio management. Let’s delve into the world of close-ended funds and understand their workings, benefits, and potential limitations.
What are Close-Ended Funds?
A close-ended fund is a type of mutual fund that issues a fixed number of shares through one initial public offering (IPO) to raise capital for its initial investments. Its shares can then be bought and sold on a stock exchange, but no new shares will be created, and no new money will flow into the fund. In contrast, an open-end fund, such as most mutual funds and exchange-traded funds (ETFs), accepts a constant flow of new investment capital.
How do Close-Ended Funds Work?
Like many mutual funds, a close-ended fund has a manager overseeing the portfolio and actively buying, selling, and holding assets. Similar to stocks and ETFs, its shares fluctuate in price throughout the trading day. However, the close-ended fund’s parent company will issue no additional shares, and the fund itself won’t buy back shares.
Close-ended funds are a type of investment vehicle that pools money from multiple investors to purchase a fixed number of shares. These funds have a fixed number of shares available for purchase, and once all shares are sold, the fund is closed to new investors. This is different from open-ended funds, which continuously issue and redeem shares based on investor demand.
Advantages of Close-Ended Funds
1. Stability for Fund Managers: Since in a close-ended fund, investors cannot redeem their units before the maturity date, the fund managers have a set asset base to work with. They are not worried about maintaining liquidity since there are no redemptions.
2. Market Price based on Demand and Supply: Like equity shares, the units of closed-ended schemes are sold on the stock exchange at prices determined by the demand and supply of the units of the scheme.
3. High Liquidity: While prima facie, closed-ended funds might seem illiquid since the fund house doesn’t allow redemption of units, the stock exchange offers umpteen opportunities to buy/sell the units.
One of the benefits of close-ended funds is that they can provide investors with access to unique investment opportunities that may not be available through other investment vehicles. For example, a close-ended fund may invest in niche markets or specialized sectors that are not easily accessible to individual investors.
Another benefit of close-ended funds is their potential for capital appreciation. Because the number of shares in the fund is fixed, the share price can increase as demand for the shares grows. This can lead to higher returns for investors, especially if the underlying investments in the fund perform well.
Disadvantages of Close-Ended Funds
However, close-ended funds also have some drawbacks. One of the main drawbacks is that they can be illiquid. Because there is a fixed number of shares available, it can be difficult for investors to sell their shares if they need to raise cash quickly. Additionally, close-ended funds can trade at a discount or premium to their net asset value (NAV), which can impact investor returns.
Not a Great Performance in the Past: The fund manager of a closed-ended fund is in a good position to create investment strategies to help him achieve the investment objectives of the scheme. However, if we look at the performance of closed-ended funds in the past, it doesn’t seem to reflect better returns as compared to open-ended schemes.
Conclusion
Investors considering close-ended funds should carefully evaluate the fund’s investment strategy, management team, fees, and liquidity before investing. It is also important to consider the fund’s historical performance and how it fits into your overall investment strategy.
In conclusion, close-ended funds can be a valuable addition to an investor’s portfolio, providing access to unique investment opportunities and potential for capital appreciation. However, investors should carefully evaluate the benefits and drawbacks of these funds before investing and ensure they align with their investment goals and risk tolerance.