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Be wary of these 6 things if you’re going to invest in close-ended mutual funds

Be wary of these 6 things if you’re going to invest in close-ended mutual funds

Be wary of these 6 things if you’re going to invest in close-ended mutual funds

Fund houses have come up with sizeable new close-ended schemes to draw investors. This was largely made possible by the market sentiment that remained positive for most of the period. About 16 new equity close-ended mutual fund schemes were open for subscription from December 2017 to March 2018. According to an industry insider, a certain category of investors seems to be lapping up close-ended funds. Unless markets go for a sustained correction, it is highly unlikely that the launch of close-ended funds will dry up in near term. Another expert adds that there are high chances of AMCs choosing the close ended path to garner fresh funds in this new financial year, thanks to the constraint for open ended schemes followed by standard categorization from SEBI.

The following are 6 points that an investor should keep in mind when he opts to invest in these funds-

  1. Difficult to exit- as an investor, you may wonder, what if a 5-year close-ended fund continues to underperform the markets/benchmark? In such a case, shouldn’t the investor be able to avail the option of rebalancing his portfolio of exiting from the fund? Experts state that though most close-ended funds are listed on Nifty, they are very thinly traded for one to exit. Often an investor needs to sell on discount to NAV.
  2. Portfolio may be liquidated with losses on maturity date- with the maturity date being fixe, irrespective of the market movement, the fund manager will need to liquidate his stock positions and return the money to investors. Consequently, the portfolio may be liquidated in bearish markets with losses on maturity.
  3. Maximizes income of the distributor and AMCs- close-ended schemes that mirror investment objectives of open-ended schemes (such as small cap, large cap, mid cap, etc.) are generally launched with the objective of maximizing the income of the distributor and the AMCs. Often there are recommendations to subscribe by distributors in these close ended funds without an analyzing one’s risk appetite and financial goals.
  4. Lack of liquidity- no short-term liquidity is available in close-ended funds. Investors cannot choose to redeem even if he is need of funds for an emergency. Investors who want interim redemptions during the investment term should not opt for fund, due to its lock-in terms.
  5. No track record of the fund and restricts wealth creation- close-ended funds are launched with NFOs which do not have any track record. Thus, one cannot review past performance and scrutinize investment portfolio. The objective of close-ended NFO is aimed to grow AUM and ignore market valuation. Investor gets stuck with fund even if the performance is poor.
  6. Concentrated portfolio and higher expense ratio- close-ended funds usually have higher expense ratio of 0.5-1.5% more than open-ended schemes. It should also be noted that it usually takes concentrated portfolio bets with only about 25-30 stock which can turn risky if you are a conservative investor.

Final word:

If you have a preference for lump-sum investments and are absolutely confident about not redeeming before maturity, you can give a shot to close-ended funds. As an expert suggests, while investing one has to understand a few things, including – what kind of filters will be used to arrive at the investible universe, kind of stocks/sectors fund manager will enter, kind of stock-specific limits, cash strategy and investment style of the fund manager in this scheme. If all these factors are found to be comfortable for an investor, he can go ahead.

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