Have you heard of or invested in the following funds:
- DHFL Pramerica Hybrid Fixed Term Fund Series 34 1240 Days
- Birla SunLife Focused Equity Fund Series 4
- ICICI Prudential India Recovery Fund Series 2
- Reliance Dual Advantage Fixed Term Fund Series VI Plan A 1094 Days
- Reliance Capital Builder Fund Series B
Theses funds represent a unique variety of funds – the closed ended funds.
Now, if you have allowed in a Fixed Maturity Plan or a Fixed Term Fund or a FMP as it is popularly known, it opens for subscription only for a fixed period, after which you cannot invest in that particular FMP. The redemption is also allowed after the specified period.
The same is true for several capital protection funds and many other funds launched in the equity space. You buy only within a specified initial subscription period post which any fresh subscription in that fund is not allowed.
Why do such closed ended funds exist?
A few reasons
- In equity funds, the certainty of the corpus available allows the fund manager to tune his investment strategy better. He may be able to take more long term calls without inviting short term pressures of redemption.
- In case of debt, the fund manager can lock-in to specified debt papers relevant to the period of the fund.
- In case of capital protection, the fund manager is fully aware about the time period available to achieve the aim and hence, frames an investment strategy accordingly.
Investors also sit calm as they are aware that the fund is locked in for a particular period.
That’s the good part. Though that’s not all.
The perils of investing in a closed ended funds
A closed ended structure is actively used to push sales. Distributors are typically given a larger upfront commissions in lieu of which they get the investors to put in their money.
The AMCs too prefer it because it gives them more control to earn their fund management fee. Cash flows become predictable.
As for as you are concerned, you can be stuck. If the fund manager departs or something goes wrong with the AMC or the investments, you cannot get out.
In some cases, there are windows of exit at intervals that you can use to withdraw your money. However, these exits can come at steep exit loads.
What should investors do?
If you look at a capital protection fund, it is no better than the structure of an MIP or a Monthly Income Plan. A portion is invested in equity for growth while the investment in debt work to at least return the principal amount. Nothing is guaranteed though.
Even in equity funds, with the same fund house, there is no particular reason that an existing open ended fund will not do better than a closed ended fund.
It is interesting to note that closed ended funds are more of a sales tool. It is easier to sell by saying “capital protection” and get those investors who are afraid of “risk”. They sound like fixed deposits.
Of course, the guaranteed recurring income to the distributors and the fund adds to the lure.
As for investors, you can avoid them and choose open ended funds with a prove track record and full liquidity.
For those who are already invested in such funds, the option is to wait and not repeat the mistake.
Finally, work with an investment advisor and then invest in direct plans. That combination can lead to a better overall result in terms of controlling risk and enhancing returns.
If you have invested in an ELSS fund or a tax saving mutual fund, you know that you cannot redeem the money till 3 years from the date of the investment.
You can invest any time but you can withdraw only after 3 years. This condition is necessary for it to become eligible for tax savings.
In that sense, this is not a closed ended fund since you can subscribe anytime.