Close-ended funds began to pick up in popularity since end 2013. These products do work well for asset management companies, or AMCs. From an investor's point of view, there are a few aspects to consider.
- The maturity date could backfire.
Close-ended funds sell on the premise that by locking in an investor for a fixed period of time, it prevents them from acting on emotion. We all know that in a market downturn, investors flee in panic. Moreover, a number of them do not have a long-term mentality. They open 5-year systematic investment plans, or SIPs, but tend to exit after two years.
A close-ended fund tends to curb this tendency by forcing investors to stay invested.
On the flip side, what if the market is in the doldrums when the fund matures? In that case the investor has not benefited at all.
Franklin India Smaller Companies Fund was launched on November 16, 2005 and closed by December 15, 2005. The date of allotment was January 13, 2006. Maturity was 60 months from the date of allotment – January 13, 2011. The point-to-point return during this period was a paltry 7.37%.
Fortunately, the fund had a 5-year tenure. Had it been just three years, it would have matured on January 13, 2009 where the point-to-point return would have been -17%. Moreover, on maturity, the fund was converted to an open-ended fund which gave investors the leeway to stay invested and wait to pull out the money when they so desired.
- There is no track record.
There are numerous open-ended funds with decent track records. There is no logical reason why an investor should bypass these funds and opt for a close-ended fund which has no track record whatsoever.
There are exceptions though- if the fund really does have something new to offer and fits nicely into the investor's portfolio. But frankly, such instances, if at all, are very few and far between.
- You have to opt for lumpsum investing.
We are unapologetic about the fact that we believe equity investors must invest systematically. In a way, investing in a close-ended fund is attempting to time the market. Of course, it could work if you got into such a fund when the market was wallowing end 2008. But at that time investors believed the world was coming to an end and fund houses were not launching such schemes.
Opt for an open-ended fund with a good track record and invest systematically. That completely takes the emotion out of the equation.
- Liquidity is an issue.
The structure of a close-ended fund means that your money has to be locked in over the tenure of the fund.
In order to provide an exit route for investors, some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchases. This is not frequent, probably twice a year. Another route is the listing on the stock exchange where liquidity is a big issue.
Regulations laid down by the Securities and Exchange Board of India, or SEBI, stipulate that at least one of the above two exit routes are provided to the investor.
- The fund manager has steady capital to contend with.
It is assumed that fund managers can do a better job simply because the closed-end structure allows them to work with a stable pool of capital.
Huge inflows in an open-ended fund would lead to the issue of cash deployment, a problem if valuations are steep. Sudden outflows may result in the manager disposing off stocks he would rather hold. As a result, a fund manager in an open-ended fund is sometimes forced to buy or sell securities at inopportune times.
In a close-ended fund, since the investment horizon of the investor and fund manager are in sync, the fund manager will not have to contend with such a situation.
But this very argument proposed by proponents of closed-end funds works against it. When stocks are available at great bargains, there are no inflows which will allow the fund managers to pick them up, unless they sell some of their existing holdings.
Of course, the exception here is if the fund was launched at a time when the market hit rock bottom. Again, in theory this sounds perfect. But as mentioned above, fund houses tend to avoid launching funds at such times since investors prefer staying away from the market.
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