Finance

Closed-end mutual fund

Closed-end mutual fund

A closed-end mutual fund is an equity or debt fund that issues a fixed amount of capital and then lists the shares for trading on a stock exchange. Once the offer period ends, investors cannot purchase or redeem the units. The closed-end fund ‘closes’ after the launch period until maturity.

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How do closed-end mutual funds work?

A closed-end fund has a professional manager who oversees the portfolio and buys and sells holding assets. Like equity, the price fluctuates throughout the trading day. But in closed-end funds, after the IPO, the fund’s parent company does not issue or redeem any additional shares. Investors can buy or sell the fund on the secondary market. These funds are launched via an NFO and traded in the market with a fixed maturity period.

Who can invest in them?

Closed-end mutual funds have a longer lock-in period and so are suitable for investors who are looking for long-term investments. They are also great for investors who want to diversify their portfolios. These funds also require a lump sum investment. The performance of the fund depends on the investment style, market conditions, investment sector, etc.

Advantages:

  • Professional management: Individual investors have access to professional portfolio managers. Investment funds offer investors access to low-cost, immense investment research, and money management expertise.
  • Stability: In a closed-end mutual fund, investors cannot redeem their units before maturity, giving fund managers a set asset base to work with. Since there are no redemptions, the managers are not worried about maintaining liquidity.
  • Demand and Supply: The shares of a closed-end fund are traded on the stock exchange at prices determined by demand and supply forces. Hence, if the demand increases and supply remains low, the units can sell at a price above the NAV.
  • Liquidity: The stock exchange offers countless opportunities to buy or sell the units of a fund and hence they are not illiquid. Investors can sell these units at the existing prices in the market.

Disadvantages:

  • Highly fund manager driven: Investors tend to examine the performance of a mutual fund over different market cycles to decide whether the investment is a good option. Unlike open-ended schemes, this data isn’t readily available in closed-end funds. Hence, the performance of the fund largely depends on the decisions of the fund manager.
  • Only one investment option: An investor can only make a lump sum investment since the units can be purchased only during the initial launch period. This increases risk.
  • Like any other instruments, closed-end funds are subject to market risk, interest rate risk, credit risk, etc.

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Bottom Line:

A closed-end fund raises money through an IPO and then trades its shares on the stock market. They often have higher returns than open-end funds. The price fluctuates according to demand and supply forces and is subject to market risks.

Author – Abha Shetty

About the author – Abha is a second-year BMS student and FRM level 1 candidate. She is very intrigued by the world of financial markets and hopes to master the art of investing and trading.

 

Related:

What are Mutual Funds

WHAT ARE HEDGE FUNDS?

 

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