Closed-end funds meant only for seasoned investors

Buy a closed-end fund only if its offers a theme that is not available within the open-end category

Mutual funds are once again launching closed-end schemes. Axis Mutual Fund and ICICI Prudential Mutual Fund are running new fund offers that end on Friday. Reliance Mutual Fund and UTI Mutual Fund have also filed applications with the Securities and Exchange Board of India (Sebi) to launch one and three closed-end equity schemes, respectively.

Wealth managers say investors who are in the process of constructing their portfolios should stay away from closed-end funds. “These funds are suitable for investors who understand the nuances of investing in equities and have a portfolio that needs new strategies to add diversification. Even then, the call should be based on how the scheme fits in the overall portfolio,” says Hemant Rustagi, chief executive officer (CEO), Wiseinvest Advisors. He adds: “If an investor has not seen different market cycles, he should focus on open-end funds in the diversified and mid-cap categories.”

Even seasoned investors should pick these funds carefully. “A closed-end scheme should offer a unique theme that is not available in open-end funds, or else the latter is preferable,” says Manoj Nagpal, CEO, Outlook Asia Capital.

Wealth managers prefer open-end schemes as they have a track record, which makes them easier to evaluate. You can see how the fund has behaved in different market cycles. In case of closed-end schemes, an investor can only judge the scheme on two parameters — fund manager and strategy. 

There has been a large increase in the number of closed-end fund launches over the past two-three years. Three years ago, stock valuations were far more attractive. Fund houses then sold these schemes to investors saying they can benefit from the turnaround in the economy and the markets. They added the advantage of being in a closed-end scheme was that the fund manager could take better calls as there was no fear of redemption if the markets turned volatile.

With the markets now at a peak, fund houses still believe there’s potential if an investor stays with equities for the long term. “The Indian economy is in a phase of strong growth aided by improving fundamentals and path-breaking reforms like Goods and Service Tax. We believe these can create a conducive environment for the emergence of newer themes which can be ideally captured in the closed-end offerings, given the in-built discipline of this category of funds,” says Sundeep Sikka, executive director and CEO, Reliance Mutual Fund.

In the past, open-end funds have fared better than closed-end ones in their respective categories (see table). If you look at small-cap and multi-cap funds, the top three performers among open-end schemes have fared better.

Analysts and wealth managers recommend open-end schemes to new investors also because of their flexibility. “You can exit an open-end scheme if it is not performing and invest elsewhere,” says Vidya Bala, head of mutual fund research at FundsIndia.com. All closed-end schemes are listed on the stock exchanges. But if an investor decides to sell, it’s difficult to get the right price. “Due to lack of liquidity, historically, closed-end schemes have had to be sold at a discount,” says Rustagi. 

Many investors also opt for the dividend option in closed-end schemes. But financial planners say this is not a wise choice. The amount of dividend payout cannot be known in advance, given that the nature of the investment is volatile (equity), while the scheme is of a fixed duration.