The trouble with closed-ended equity mutual funds

Closed-ended equity mutual fund NFO started cropping up frequently a little before the 2014 Lok Sabha elections. They represent the efforts of AMC and distributors to lock-in AUM and therefore, profits regardless of market volatility.

I had earlier written about why one should not invest in closed-ended mutual funds from a financial goal planning point of view. In this post, I would like to add a couple more points that investors tend to forget while investing in closed-ended mutual funds, especially the equity-based ones.

Are closed-ended fund better than open-ended funds?

Many claim that equity closed ended mutual funds will provide ‘better’ returns because the fund manager can function without fear of redemptions. The same myth exists about ELSS Fund Lock-in too!

It is impossible to compare returns of closed-ended funds and open-ended funds unless they started on the same day with identical portfolios! This is true for ELSS vs other categories too, but at least ELSS funds are not truly closed-ended funds.

Since this question cannot be answered logically, there is no point asking it!

The concept of a ‘maturity date’ is dangerous!

Closed-ended funds have a maturity date at the end of which the investor could either redeem or let the investment continue if the AMC chooses to convert the fund as open-ended.

A maturity date for an equity fund is as silly as it is dangerous. The typical investor would end expecting ‘good returns’ at the end of 3 years or 5 years. This may or may not happen with pretty much equal probability. Read more: Equity investing: How to define ‘long-term’ and ‘short-term’

Sure, there are disclaimers to this effect all over the place. How many read them? How many understand them? How many salesmen mention the high proability of losing money in such funds?

Equity closed-ended funds are only suitable for those who clearly understand volatility.

In a FMP which is a debt closed-ended fund, the concept of a maturity date makes sense. As long as the bonds are not devalued in terms of credit rating, there is more than a reasonable chance of getting ‘good returns’. Read more: Understanding Credit Rating Risk in Debt Mutual Funds

This is also true of the NPS (the biggest closed-ended mutual fund!) if it has no equity component. I know of investors who have 50% equity exposure in NPS and yet talk about the ‘maturity value’. Read more: NPS investments are mutual fund investments!

If you are not an experienced equity investor, I would strongly suggest that you stay away from equity closed-ended mutual funds.

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