Should you invest in closed-end funds?
Posted by: Arti Bhargava on Aug 07, 2017, 10.51 AM IST
Rishabh is a doctor and wants to invest for his daughter's higher education. He has been watching the stock market rally from the sidelines. His friend tells him that a closed-ended fund is ideal for long-term investors like him because the 7-year lock-in period ensures that he stays invested at least for a specified length of time, enabling him to benefit from capital appreciation.
Moreover, the fund will have a stable AUM, allowing the fund manager to invest in stocks where there is longterm value and growth potential, without worrying about redemption pressures. It sounds like a good idea. Should Rishabh take the plunge?
The most important aspect of investing in a closed-ended fund is the timing. In a rising market scenario, when valuations are also rising, investing a lump sum could be risky. Systematic investing is the ideal way to invest in such markets.
However, a closed-ended fund requires lump sum investments, which may cause trouble for Rishabh, if the markets were to fall. Again, when buying a closed-ended fund, Rishabh should bear in mind that there is no track record of what he is buying into. The name and the theme may sound catchy, but whether it will deliver performance is a call he will have to make.
So he must invest being fully aware of what kind of stocks and sectors he is investing into. Let's assume he bought it and two years down the line, he realised that it is an under-performer that he would like to redeem. Does he have that option? He can theoretically sell it off on the stock exchange as it will be compulsorily listed.
However, in reality finding a buyer for units is a tough task and such trades rarely happen. To add to his woes, he might end up selling his holding at a steep discount, which is usually the case. Performance of a closed-ended investment may depend on the fund manager's skill, investment style and the stocks or sectors that the fund invests in. It also depends on the holding period and most importantly, the prevailing market conditions.
Sounds similar to investing in an open-ended fund? If yes, then is it worthwhile for Rishabh to invest in a closedend funded at the cost of liquidity and option of systematic investing.
(The content on this page is courtesy Centre for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.)
This article appeared in Economic Times dated Aug 07, 2017, 10.51 AM IST