Closed Ended Funds
When investors explore mutual funds, they often come across two broad types. One is the commonly known open ended fund. The other is the lesser discussed but equally important closed ended fund.
Closed ended funds bring structure, discipline and stability to a portfolio by fixing the fund size and locking in money for a set period. This glossary entry explains what closed ended funds are, how they operate, why investors choose them and what to consider before investing.
What are Closed Ended Funds?
Closed ended funds are mutual funds that raise a fixed amount of capital during a new fund offer and remain closed for subscriptions and redemptions until the lock in period ends.
Investors can buy units only during the initial offer. After that, the fund does not accept new money or allow withdrawals until maturity.
This fixed structure gives fund managers stability because they do not have to deal with continuous inflows and outflows. It allows them to follow long term strategies without interruption.
Key Characteristics of Closed Ended Funds
1. Fixed Maturity
These funds come with a predetermined maturity period. It may range from three to seven years depending on the scheme.
2. No Ongoing Subscriptions
Once the initial offer period closes, no additional units can be purchased directly from the fund.
3. Limited Redemption
Investors cannot redeem units before maturity. This encourages discipline and long term investing.
4. Listed on Stock Exchanges
Closed ended funds are listed on exchanges. Investors who want to exit early can trade their units on the exchange, provided liquidity is available.
5. Stable Asset Base
Since money does not flow in and out daily, fund managers can invest with a longer horizon and focus on strategy instead of liquidity management.
How Closed Ended Funds Work?
1. New Fund Offer
The fund raises capital from investors during the NFO window. Units are allotted at a fixed price.
2. Investment Phase
Fund managers deploy the collected capital across securities such as bonds, stocks or hybrid instruments.
3. Listing on Exchange
The units are listed, allowing buying and selling between investors who trade through market prices.
4. Lock In Until Maturity
Investors stay invested for the entire tenure unless they choose to sell units on the exchange.
5. Payout at Maturity
Once the fund matures, investors receive the redemption value based on the current NAV.
Types of Closed Ended Funds
1. Fixed Maturity Plans (FMPs)
Debt oriented funds that invest in fixed income instruments with matching maturity.
2. ELSS Closed Ended Options
Some Equity Linked Savings Schemes offer a three year lock in in a closed ended format.
3. Interval Funds
Operate like a hybrid structure where buying and selling is allowed only during specific intervals.
Why Investors Choose Closed Ended Funds
1. Long Term Discipline
The lock in period reduces impulsive exits and encourages long term focus.
2. Potential for Better Returns
Since inflows and outflows are restricted, fund managers can take concentrated or longer term positions.
3. Access to Structured Strategies
Many closed ended funds focus on maturity matching, debt strategies or opportunity based investing.
4. Predictability
For debt based closed ended funds, aligned maturity can improve visibility of returns.
Risks to Consider
Liquidity Risk
Units may not always be actively traded on exchanges. Investors who want to exit early may not find buyers.
Market Price Fluctuation
Listed unit prices may deviate from the NAV due to demand and supply.
Interest Rate Risk
Debt oriented closed ended funds are exposed to interest rate movements.
No Early Redemption
Investors must be prepared to stay locked in until maturity unless market liquidity helps.
Real World Analogy
Think of a closed ended fund as a prepaid group trip. Everyone pays upfront and once the trip begins, no new travellers are added and no one leaves until the tour ends. This helps the planner manage resources smoothly. Similarly, a closed ended fund allows the manager to plan investments without worrying about daily cash flows.
Who Should Consider Closed Ended Funds
- Long Term Investors
Those comfortable with locking in money for a defined period.
- Investors Seeking Predictability
Especially those investing in debt oriented options.
- Investors Looking for Disciplined Structures
People who want to avoid frequent trading or emotional decision making.
How Closed Ended Funds Compare to Open Ended Funds?
- Buying and Selling
Open ended funds allow daily purchases and redemptions. Closed ended funds do not.
- NAV Influence
Open ended funds deal with constant inflows and outflows. Closed ended funds have a stable corpus.
- Liquidity Source
Open ended funds offer liquidity directly from the fund house. Closed ended funds offer liquidity through stock exchanges.
Conclusion
Closed ended funds bring structure and stability to an investor’s portfolio. Their fixed maturity and disciplined format make them useful for long term strategies, especially in debt and tax saving categories. While they offer potential advantages, investors must understand the lock in, liquidity challenges and market risks before choosing them. Selecting the right scheme aligned with one’s goals and time horizon can help make closed ended funds a valuable part of a diversified portfolio.
FAQs
1. Can I exit a closed ended fund before maturity
Yes, but only by selling units on the stock exchange. Early redemption directly with the fund house is not allowed.
2. Are closed ended funds suitable for beginners
They can be, but beginners should ensure they are comfortable with the lock in period.
3. Do closed ended funds offer guaranteed returns
No. Returns depend on market performance and the underlying investments.
4. Why do closed ended funds trade at a discount to NAV
It often happens due to low liquidity or lower demand for the units.
5. How do I choose the right closed ended fund
Consider the fund objective, portfolio quality, past performance of the fund house and your investment horizon.
