Don't fall for the investment themes of closed-end funds

These funds don't allow investors to exit mid-way in order to cash in on returns or if they aren't happy with their performance

While the stock market has been highly volatile with a downward bias, mutual fund houses are back to launching closed-end equity funds. ICICI Prudential has launched India Recovery Fund-Series 4 and Birla Sun Life has launched Emerging Leaders Fund-Series 7.

Birla Sun Life's new fund will invest in mid- and small-cap companies. The fund house makes a case for investment pointing out that these companies have seen lesser correction while showing stronger corporate earnings growth. And the fund house believes that are strong indicators that market will turnaround soon. The key sectors this fund will invest in include roads, railways, urban infrastructure, renewable energy, agrochemicals, textiles, cement, and automobile.

The fund will mature after three years and six months. To give investors liquidity, the fund will be listed on the National Stock Exchange 15 days after the units are allocated.

ICICI Prudential's new fund bets on large cap stocks as it sees high value in these companies will benefit from the economic recovery. The fund will mature after three years (1,099 days).

The themes that these funds are looking at are sound and are likely to play out in the long run. Investment advisors and analysts, however, say that investors are better off looking at alternative open-ended funds rather than closed-end ones.

"The biggest drawback in closed-end fund is the liquidity. An investor cannot exit mid-way," says Dhaval Kapadia, director - Investment Advisory at Morningstar Investment Adviser, India. He explains that an investor may need to exit mid-way for several reasons. Say, if the fund doesn't perform as expected or the scheme has made good returns and investors want to cash in or there's a certain view of the investor on the market. While Birla Sun Life's new fund offers exit opportunity through listing on stock exchange; the price prevailing after listing will be function of the market. Investor may or may not get the fair value of the units held. Open-ended schemes also give investors the flexibility to opt out any time they wish.

Vidya Bala, head of Mutual Fund Research at FundsIndia say that funds with a proven track record, which have see different market cycles, are better than closed-end funds. Both the fund houses are reputed and have open-ended funds with track records in the large as well as small- and mid-cap space that investors can look at.

Kapadia also points out that there's no research any where in the world that proves closed-end schemes are better than the open-ended ones or vice versa. Birla Sun Life's earlier funds in the same series have negative returns between 10.21 per cent and 11.52 per cent in the past year. The fund house's other mid and small cap schemes have similar performance.

In case of ICICI Prudential, some of its large cap open-ended funds have given even better returns compared to the closed-end funds launched earlier in the series.

Bala also points that most of the open-ended equity funds are already following the theme that these funds are pursuing. "Many funds are slowly building up stock position in sectors such as auto and cement," Bala says.

Many first time investors opt for closed-end funds thinking they are like fixed deposits and will help them be disciplined. These individuals can give bank a mandate and automate their systematic investment plan in an open-ended equity scheme, say investment advisors.