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What are Closed Ended Mutual Funds

Closed-ended mutual funds are investment funds that issue a fixed number of shares through an Initial Public Offering (IPO). After the IPO, these shares are traded on stock exchanges like regular stocks. Unlike open-ended funds, investors cannot redeem their shares directly with the fund until its maturity. 


Advantages of Closed-Ended Mutual Funds

Stability for the Fund Managers

Closed-ended funds provide stability to fund managers since the invested capital remains fixed for the duration of the fund. Once investors purchase units, they cannot make withdrawals until the fund matures. This allows fund managers to make long-term investment decisions and allocate resources to less liquid assets such as small-cap stocks, bonds, or real estate, which may offer higher returns over time. Unlike open-ended funds, closed-ended funds are not subject to sudden cash outflows, making them easier to manage.

Market Price based on Demand and Supply

The market price of closed-ended fund units is determined by demand and supply on the stock exchange and can differ from the fund's Net Asset Value (NAV).
•    High demand may cause the fund to trade at a premium (above NAV).
•    Low demand may result in the fund trading at a discount (below NAV).
This characteristic allows investors to take advantage of market inefficiencies by buying units at lower prices or selling them at higher prices. However, short-term price fluctuations influenced by market sentiment or macroeconomic factors may not accurately reflect the fund's underlying performance.

Liquidity Through Trading

Investors can buy or sell units during trading hours, depending on the market's activity. However, the ease of trading depends on the liquidity of the specific fund:
•    Highly traded funds have narrower bid-ask spreads, making transactions smoother.
•    Less actively traded funds may face wider bid-ask spreads, making trading slightly more challenging.
The listing on stock exchanges allows investors to rapidly open or close positions when there is sufficient market demand.

Disadvantages of Closed-Ended Mutual Funds

Historical Underperformance

They often trade at a discount to NAV, reflecting low investor confidence in the fund’s performance or future prospects. As a result, these funds may fail to deliver returns as high as forecasted, especially when competing with more diversified investment categories.

Only Lump Sum Investment option available

Unlike open-ended funds, closed-ended funds do not allow Systematic Investment Plans (SIPs). Investors must invest a lump sum during the IPO stage, as no further contributions can be made afterward unless more units are bought from the secondary market. This limitation can be inconvenient for investors who prefer to invest smaller amounts periodically, a strategy that helps average out costs and reduces investment risks over time.

How to Invest in Close-Ended Funds?

To invest in closed-ended funds, you can participate in the IPO stage by purchasing units at the specified price. Alternatively, after the IPO, you can trade these units on the Nepal Stock Exchange (NEPSE). To do so, you need to open a brokerage account licensed by SEBON. Once your account is active, you can place market or limit orders to buy or sell units on the stock exchange.

 

FAQs

What is a close-ended mutual fund in simple terms?

A closed-ended mutual fund is a type of mutual fund that issues a fixed number of shares and is traded on the stock exchange, similar to stocks.


Is it good to invest in a closed-end mutual fund?

Investing in a closed-end mutual fund can be beneficial if you have a long-term investment horizon and are seeking potentially higher returns. However, it involves higher risks and lower liquidity, so it may not suit all investors.


What is the risk of a closed-end fund?

The main risks of closed-end funds include:
•    Market Volatility: Price fluctuations due to market conditions.
•    Discounts to NAV: Units may trade at prices lower than their Net Asset Value.
•    Lower Liquidity: Limited opportunities to trade compared to open-ended funds.


How do you identify closed-end funds?

Closed-end funds are listed on stock exchanges and have a fixed number of shares, unlike open-ended funds, which issue and redeem shares on demand.