Is a close ended fund for you?

Should I invest in one more ELSS or in some other fund?

What exactly is a close-ended fund? Who should opt for them?

- Ashish Acharya

ELSS options

Invest more in an Equity Linked Saving Scheme only if you have not already exhausted the Rs 1,00,000 limit for the purpose of tax exemption.

In that case, we advice you go for a tax-planning fund with a good track record of performance, rather than a new fund. We suggest you read Haven't planned your taxes yet?

If, however, more investments in ELSS will not provide you with any tax exemption, you can go for a diversified equity fund. This is a mutual fund that invests in the shares of various companies of various sectors. It is similar to an ELSS except that it gives absolutely no tax benefit.

Close ended funds

In the last few years, close-ended funds were not popular. But they are coming back in vogue and we have seen the launch of four close-end funds recently. The most recent being Franklin India Small Companies Fund and HDFC Long Term Equity Fund.  

Open ended funds means that you can buy and sell the units of the fund anytime.

Closed-end funds are the ones in which you can invest (buy units) only at the time of their launch. Once the launch date is over, they do not accept subsequent investments.

If you invest in a close ended fund right now, then look at it as an investment which you are not going to redeem (sell the units) at least during the tenure of the fund.

For instance, take the HDFC Long Term Equity Fund. This is a five-year close ended fund. The scheme opened for subscription on December 30, 2005 to January 27, 2006.

So if you wanted to buy these units, you should have done so during the offer period.

What happens on maturity?

Either the funds are redeemed (all the money is returned to the investors) or it is converted into an open-ended fund.

If you want to sell your units before maturity, some funds allow you to do so buy charge you a high exit load (percentage you pay on the total amount obtained by selling the units).

Let's once again talk about the HDFC Fund. After completion of five years, it will get automatically converted into an open ended fund where you can buy and sell the units anytime.

If you want to sell the units before that you can. If you sell within 12 months of investing, you will have to pay an exit load of 4%. As the tenure of investment gets longer, the exit load decreases. It decreases by 1% every year and is 0% in the last year.

Some funds do not allow you to sell the units before the maturity of the fund. Instead, the units are listed and traded on the stock exchange just like shares.

In such a case, you can sell your units on the stock exchange at the prevailing price. Do note, this price is not the Net Asset Value. It is just the price that is available on the stock exchange – the price that a buyer is willing to pay.

Should you?

The charm of a close-end fund is that the money invested in them is supposed to be more stable than open-end funds.

Since the fund manager can afford to be indifferent to short-term market volatilities, he can make long term bets which will prove beneficial.

In open ended funds, the fund manager has to always deal with fresh money coming in and money going out. The latter takes place when the market dips, people tend to sell in panic.

Therefore, the close ended fund manager can invest more effectively, based upon the tenure of the fund and does not have to bother about sudden redemption pressures.

If you invest in a close ended fund and the stock market dips substantially, it would be wise not to sell your units in a hurry. Give your investment enough time to recover when the tide turns favourable again.

While this is true for any equity investment, it is all the more relevant for a close ended fund. That's because in an open ended fund you can invest via a Systematic Investment Plan, whereby you invest small portions regularly. In a close ended fund, the SIP is not allowed, so you investments are all one time lump-sum investments.

Since liquidity is limited compared to an open-ended fund, it is better to look at it as an investment which you will not be redeeming during the tenure of the fund.

Therefore, look at the tenure of the fund and allocate money to it that you will not be needing during that tenure.

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Illustration: Dominic Xavier