What is the Closed-End Fund?

Explanation

  • These are professionally managed funds, the same as a mutual fundMutual FundA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more. They have a dedicated relationship manager who takes care of the portfolio and continually trades, i.e., buying/selling and holding scripts per market conditions.Like exchange-traded fundsExchange-traded FundsAn exchange-traded fund (ETF) is a security that contains many types of securities such as bonds, stocks, commodities, and so on, and that trades on the exchange like a stock, with the price fluctuating many times throughout the day when the exchange-traded fund is bought and sold on the exchange.read more, these are traded as equity as their prices change throughout the trading session. However, these are very similar to equity traded funds but have a huge difference also.After the initial public offeringInitial Public OfferingAn initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. IPO is a means of raising capital for companies by allowing them to trade their shares on the stock exchange.read more, the company cannot issue further shares under closed-ended funds. Also, these funds cannot be redeemed through the buyback of sharesBuyback Of SharesShare buyback refers to the repurchase of the company’s own outstanding shares from the open market using the accumulated funds of the company to decrease the outstanding shares in the company’s balance sheet. This is done either to increase the value of the existing shares or to prevent various shareholders from controlling the company.read more. The only thing possible is for investors to buy and sell these shares in the secondary marketSecondary MarketA secondary market is a platform where investors can easily buy or sell securities once issued by the original issuer, be it a bank, corporation, or government entity. Also referred to as an aftermarket, it allows investors to trade securities freely without interference from those who issue them.read more.

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How does it Work?

  • These are similar to exchange-traded funds or mutual funds. These funds are maintained by investment advisors, run by expert management who initiates trading on a set portfolio. They have several features that make them popular among their class.They charge some fees, which yield revenue to investors through capital gain. This is categorized as an investment company accessible by the general public for investing.The portfolio and portfolio manager must be registered with the securities and exchange commission and comply with exchange guidelines/requirements.Per the rules of the security exchange commission, it can be launched only by way of an initial public offering open for a short period (2-10 days) as allowed by exchange rules, as permitted.Afterward, these funds are treated as shares and are traded in the stock market as equity scripts. The fund’s price can be more or less than the initial public offering price depending on the demand and supply in the market.

Closed-End Funds Example

  • HDFC Equity Opportunities Fund – It’s a large-cap closed-end fund maturing in July 2020 corpus of 1118 crore traded at 9.85 against 10.65 NAV with an 8.1% discount.ICICI Prudential Value Fund – It is a valuable fund with assets of 1779 crore, attaining maturity in June 2021, trading at 9.2 against 10.38 NAV with a 12.8% discount.Units of ICICI Prudential Bharat Consumption Fund – It is a series II fund with assets of 267 crores traded at 8.79 against 9.91 NAV with a 12.9% discount.

How to Invest in the Closed-End Fund?

  • Investment in closed-end funds can be made directly in markets or through agents. Before investing, an investor must ensure that he is investing through a distributor registered with the association of mutual funds, which deals in such funds having ARN allotted by the association. It can also be done by contacting mutual fund distributors and asking them for necessary formalities and forms and applications which need to be completed.If investment needs to be made through a direct plan, then a financial advisor is required, which is available through distributors. Still, there is no need to pay any commission to the distributor for the advisory services. Distributors must disclose all the tariff commissions and charges for all available schemes.Investors can invest directly by visiting closed-end funds, mutual funds branches, or online websites. Physical forms can be submitted to agents and distributors who provide such services.

Before investing, the investor must check the track record of funds and schemes and refer to product labeling.

Labeling must contain –

  • Nature of schemeInvestment objectiveLevel of riskScheme information documents

Advantages

  • Stability – These are stable with their asset base. At the time of NFO, these funds gathered a vast asset base. The fund manager is at minimal risk of asset redemption and the change in the asset. These funds can be invested in other financial assetsFinancial AssetsFinancial assets are investment assets whose value derives from a contractual claim on what they represent. These are liquid assets because the economic resources or ownership can be converted into a valuable asset such as cash.read more, equity, or debt securities.New Opportunities – It allows investors to invest in a wide range of new and creative strategies.Freedom from Large Flows – There is no risk of massive inflows and outflows in closed-end funds. Investor money is locked until the time of maturity. As a result, the fund manager is capable of making rational decisions.Enhanced Flexibility – The investor is free to sell the fund and liquidate his position per rules made by the fund house. These units can be sold in the market during trade hours.The fund managers can create a unique Portfolio – An impressive portfolio to earn better returns.Trading on Stock Exchanges – Investors can trade units of their closed-end fund on a stock exchange. Prices may vary from the net asset value of funds.

Disadvantages

  • Cost – Subscriber has to pay massive fees on buying or selling unit,Subscribing Option – Can be purchased only through brokers or intermediaries.Prompt Changes – Portfolios under such funds are usually unpredictable and subjected to rapid changes.Liquidity – These funds offer less liquidity as compared to open-end funds.Pricing – Discounting factorsDiscounting FactorsDiscount Factor is a weighing factor most often used to find the present value of future cash flows, i.e., to calculate the Net Present Value (NPV). It is determined by,
  • 1 / {1 * (1 + Discount Rate) Period Number}read more may lower the price of the closed-ended funds.

Conclusion

  • This can be described as a professionally managed fund containing a fixed proportion of scripts within itself (a defined portfolio) offered during the initial public offering. It cannot be redeemed from the funds but can only be traded in secondary markets.These funds offer broad benefits like providing stability, flexibility, fixed non-redeemable funds, a unique portfolio, and exchange trading options but also have shortcomings like locking of funds that cannot be redeemed from funds (one can get out by trading on the secondary market), cost of subscribing is more as specific fees need to be paid to portfolio managersPortfolio ManagersA portfolio manager is a financial market expert who strategically designs investment portfolios.read more, the unpredictability of markets, limitations in subscribing options.

This has been a guide to What is the Closed-End Fund & its Definition. Here we discuss how to invest in closed-end funds and how it works, along with examples and differences from open-end funds. You can learn more about it from the following articles –

  • Shares vs Mutual FundsMutual Fund TypesOpen-Ended vs Closed-Ended Mutual FundsMutual Fund Analyst