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5 reasons why avoid investing in closed- ended mutual funds

Closed ended funds come with drawbacks such as lack of track record, no liquidity and absence of asset rebalancing.

July 27, 2015 / 10:58 AM IST

Manikaran SingalIn the last year and a half, there were almost 40-45 closed ended equity funds that had been launched, which collected more than Rs 5000 crore from investors. Starting with the value theme which said stocks are available at discounts, to ‘Make in India’ theme after the changes in political scenario, mutual fund houses had launched many closed ended funds. Some fund houses had come up with multiple series of the same fund, and collected good money. Announcing closed ended funds makes good business sense for asset management companies (AMCs), as it gathers stable asset base for them and thus a regular and clear income stream, but it has many drawbacks for investors. Few are pointed as under.No past track record in New Fund Offer (NFO) – To make you invest in a particular scheme, fund houses have to come up with an exciting theme and catchy name. But the launch would be an NFO. An NFO doesn’t have a performance track record. You won’t have any data to make your decision on. Performance as compared to peers, alpha generation as compared to funds own benchmark and scheme sector average etc. are some of other numbers which we consider while selecting a fund to invest in and all these would not be available in an NFO.Also you can’t be sure if the theme on which the fund portfolio would be based on, will actually work in future or not. Low liquidity – Once invested you have to stay put for specific number of years. Even if in between you feel that fund’s performance is coming down or is not doing as per your expectation, you won’t have an option to come out. If you are investment is based on the trust on a particular fund manager, what if he leaves the AMC or starts managing another fund? However you may sell out your holding on stock exchange, if you can find a buyer there as all the close ended funds have to be compulsorily listed. Getting a buyer for units is a tough task and such trades rarely happen. To add to your woes it has been seen that stock exchange transactions in close ended funds always happen at a steep discount.It doesn’t allow systematic purchases – Most of the closed ended funds come up when markets are doing well, when it is easy to convince investors to put in money. But in rising market scenario when valuations are also rising, investing lump sum could be risky. Moreover you never know which side market will move next day, so it is always better to take exposure into equity market through mutual funds using staggered or systematic route like systematic investment plan or systematic transfer plan.Closed ended schemes require lump sum investments which may make an investor uncomfortable especially in falling markets when he could not even average out the investments by buying more.Asset allocation/rebalancing is not possible-All those who make investments using goal based planning, must know the importance of asset allocation in an investment portfolio. Investing in closed ended funds doesn’t provide the option of partial redemption or additional purchase, and both these restrictions don’t go well in an asset allocated structure. In the rising equity market you may need to partially withdraw from equity funds and put into debt funds and the other way round in a falling equity market. This is not possible in closed ended structure.No extra returns due to structure- There are claims such as these schemes ensure commitment from investors for a specific time frame which helps fund manager to take risky calls. Investors do not run away in a volatile market. But even after this “so called benefit” no significant performance has been witnessed in any closed ended funds as compared to their open ended peers. Investors suffer from recency effect, which is a behavioral bias and leads people to believe that the recent happenings will continue for long. In financial markets this can be gauged from the way the investments start pouring in due to recent stock market performance, and also when investors exit looking at the recent fall. In both the situations there’s no rational basis of entering or exiting investments, thus impacting the overall investments portfolio very badly. Mutual funds know how investors behave and that’s why they come up with as many new funds as they can to take advantage of investors upbeat sentiments. But investors should be wary of these tactics and should make investments only on the basis of goals. Closed ended funds do not fit in to a properly designed goal based portfolio. Author is a member of The Financial Planners’ Guild , India (FPGI). FPGI is an association of Practicing Certified Financial Planners to create awareness about Financial Planning among the public, promote professional excellence and ensure high quality practice standards