Usually when people speak about mutual fund, most mean open ended funds. Howev- er, there's another type of fund, which is a lot differ- ent from open ended funds, called closed ended funds.
A close-ended fund issue units to investors only once, when they launch an offer, that is during the new fund offer (NFO). Af- ter that these units are listed on the stock ex- changes and could be trad- ed just like stocks are traded.
Within an open ended fund structure the mutual fund house can sell an un- limited number of units to investors. Investors can al- so sell theirs units back to the fund house if they need to redeem their in- vestments.
In contrast, under the closed ended fund struc- ture, the fund house sells a definite number of units to its investors during the initial period of subscrip- tion. After that no new money is allowed in the fund. If its investors need to redeem their money, they can sell their units in the stock market to other willing new investors into the fund. Also while open ended funds could run for perpetuity, closed ended funds are run for a defi- nite period of time. After that, the fund is either ter- minated by returning the money to investors or is made an open ended one.
All closed ended funds are listed although most are not frequently traded. And most often these units trade at a discount to the net asset value of the fund. So in a way, as an investor you can get as- sets at a price that is low- er than what it is actually valued at. Usually the gap between the discount and the NAV narrows as the fund nears its date of clo- sure. Alternately, if too many people buy the units, its market price would increase and the discount would narrow down.
ADVANTAGES OF CLOSED ENDED FUNDS
Seen from the other side, that is from the side of the fund house and the fund manager of a closed ended fund, since no new money comes into the fund, the fund manager has the lib- erty to a long term view of his/her portfolio and stay invested in the stocks in the portfolio without the pressure of pre-mature liquidation. This is one advantage of closed ended funds that fund managers in most open ended funds do not enjoy.
There are other advan- tages also of closed ended funds. Investors can wit- ness some smart gains as and when the discount to the NAV narrows. There are times when closed ended funds generate higher level of income compared to their open ended peers as the former has the flexibility (if the mandate permits) to build a concentrated portfolio that appreciates faster than a widely diversified portfolio.
As the name suggests, a concentrated portfolio is one that holds a limited number of stocks. To some extent such a portfo- lio compromises on the di- versification aspect of a portfolio but that is done to achieve a higher level of capital appreciation for the portfolio.
Fund industry officials say that before investing in a closed ended fund in- vestors should always ei- ther research themselves or they should seek advice from registered and quali- fied investment advisor.
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