What Are Close Ended Mutual Funds?

What Are Close Ended Mutual Funds?

Close ended mutual funds is a type of mutual fund scheme that has a maturity date attached to it. This means that when you invest in such a fund, your money is locked in until the fund reaches its specified maturity date, typically ranging from 3 to 5 years or more.

When an Asset Management Company (AMC) issues a new mutual fund scheme, they launch it through an NFO (New Fund Offer). NFO of a mutual fund similar to how an IPO for stock works. The NFO of a close ended fund, is introduced with a fixed number of mutual fund units. Investors can only invest in the fund when the NFO is open (Fact: NFOs for close ended schemes are only open for 15 days). Once the NFO for this fund closes, investors cannot buy or sell their units until maturity.

However, SEBI (Securities & Exchange Board of India) wanted to provide investors with the option to sell their funds before the maturity date. Hence, it was decided that once the NFO is over, units of these funds can be listed on a stock exchange. These units can then be traded like stocks in the market at a premium or discount on the NAV of the fund

How Do Close Ended Mutual Funds Work?

A mutual fund can be both open ended and closed ended. This information is presented in the Scheme Information Document (SID) that the AMC releases. This is a document that contains key information about the mutual fund scheme. Some examples of close-ended mutual funds are ICICI Prudential Growth Fund, SBI Tax Advantage Fund, etc.

In the NFO, the asset management company raises funds for the scheme. What makes close-ended funds different from any other NFO is that it only has limited units to offer. SEBI has laid down some key points for close-ended schemes, the foremost being that such funds must have at least 20 investors and secondly no single investor can own more than 25% of the total corpus invested in the scheme or plan.

If there aren’t at least 20 investors, the scheme or plan will automatically close as per SEBI's rules. This happens without SEBI needing to give a special notice. If one person owns more than 25% of the total investments, the extra amount over 25% will not be allowed and will be refunded within 6 weeks from the date the NFO is closed.

Like with any other fund, close ended mutual funds also have a fund manager that actively buys or sells assets. The NAV of the fund also fluctuates throughout market hours based on this activity. Asset management companies also charge expense ratios from investors for managing their funds. Once the maturity period for such a fund is over, investors can redeem their money or the AMC can opt to convert this fund into an open ended fund.

How Are Close Ended Mutual Funds Different From Open Ended Mutual Funds?

Unlike close ended mutual funds, open ended mutual funds do not come with a maturity date. This means that these funds can continue to exist forever. Moreover open ended mutual funds can be bought or sold at any time even after the NFO is over.

The management aspect of both funds are similar, but few factors that really differentiate the two are how investors invest in these funds and how the value of these funds are derived. Let’s understand: In close-ended mutual funds only a lump sum amount can be invested, in an open-ended mutual fund on the other hand, you can either make a lump sum investment or set up a SIP.

Another major difference between the two is that with close-ended schemes there is no track record of historical performance. Investors learn about the fund with the NFO and choose to invest in it on the basis of the SID. While in an open-ended scheme, investors have access to multiple past performance records that they can access before making an investment.

Here’s a table view for you to clearly understand these differences:

How Can I Invest In Close Ended Funds?

If you wish to invest in close ended funds, you can do so easily on the INDmoney app. Follow the instructions below to get started:

Step 1: Open the INDmoney app. If you don’t have a Demat A/C, you can begin by creating one. This only takes a few minutes and is completely free and secure.

Step 2: Head to the ‘Mutual Funds’ tab from the bottom navigation bar. Scroll to find ‘NFO’. This section updates on the basis of the latest NFOs floating in the market. You can also directly search for NFO in the search bar.

Step 3: Look for close-ended mutual fund schemes. Select and read what the fund has to offer and its objective.

Step 4: Select the amount you wish to invest and confirm.

When Do Close Ended Mutual Funds Mature?

Every closed ended mutual fund comes with a maturity date. It could be anywhere between 3 years to 5 years. If you invest in a mutual fund that has a maturity date after 5 years, this also means that you have a lock-in period for 5 years. You can of course, also trade the units of these funds in the secondary market if need arises.

Should I Invest In Close Ended Mutual Funds?

We think closed ended mutual funds are a good option if you have a long-term investment horizon and you can park lump sum money at the inception of the fund. Further if you do not easily think about redeeming your investments.

To decide whether you should invest in close ended mutual funds or not, let’s first revise a couple of points that we learned about these funds:

• They have a lock-in period
• They are actively managed
• You can only invest lump sum
• You cannot redeem funds until maturity
• You can trade units of these funds on stock exchange 

Now, the features of these funds tell us that it is suitable for someone who is comfortable with allocating funds for a fixed period of time. Moreover these funds require a lump sum investment, hence if your plan is to set up a SIP; it will not be possible with these funds. 

These funds are actively managed and there’s constant activity of buying and selling involved which means that the value of the fund changes everyday. If you’re someone who gets uneasy when the value of your investments drop, then this may not be the best option.

What Are The Benefits Of Investing In Close Ended Mutual Funds?

If by now, you’ve found close ended mutual funds an interesting investment, here are the benefits of these funds. These advantages are helpful to you as an investor and to the asset management company as a fund house.

Stability for AMC: The foremost aspect that sets this category of funds apart from any other fund is that the fund manager has to deal with a fixed amount of assets. Since the fund house does not buy back units from the investor, they’re not required to maintain high level of cash reserves, this ensures efficiency and helps the AMC deploy strategies that can help them achieve the objectives of the fund effectively.

Better returns for Investors: Secondly, investors cannot sell their mutual fund units directly to the fund house, but they can trade it on a secondary market. This means there is a very high possibility that investors can trade units at a premium which is higher than the NAV of the fund. External investors can be willing to invest in these funds even if they have to pay a premium for it.

Lower Operating Costs for both: Lastly, since there are no active buyers for this fund and investors cannot redeem their funds; the cost of maintaining these funds are less. This is beneficial to the AUM and the investors both. AUM spends less money by not getting involved in these transactions and benefits from the lower turnover rates and investors benefit from lower expense ratio (Asset management fees).  

What Is The Tax Implication On Close Ended Mutual Funds?

The taxability of the closed-ended fund will depend on the percentage of investment in equity and debt. If the fund invests at least 65% of its assets in equity or equity-related instruments, it is considered an equity fund. Whereas a fund is a debt fund if it invests at least 65% in debt instruments. Here’s a look at how they are taxed:

Taxation of Closed-ended Equity Funds

The tax liability will depend on your holding period. If you redeem your mutual fund units within 12 months, the gains are called short-term capital gains. They are taxed at 20%.

On the other hand,  If you redeem your mutual fund units after 12 months, the gains earned are known as long-term capital gains. You don’t have to pay any taxes on gains up to ₹1.25 lakh in a financial year. While returns above that are taxed at 12.5%.

Taxation of Closed-ended Debt Funds

The date and duration of investment in the case of debt funds determine your overall tax.

For Investments made on or after April 1, 2023: Gains made on debt funds will be taxed as per the investor’s income tax slab rate irrespective of the holding period.

For Investments made before April 1, 2023: The taxation on gains from mutual fund investments depends on the holding period. If you sell your mutual fund units within 24 months, the gains will be taxed according to your applicable income tax slab rate. Conversely, if you hold and then sell your units after 24 months, the gains will be taxed at a rate of 12.5%, with no indexation benefit.

Let’s understand your tax implication with an example: 

For close-ended equity funds

Say you invested ₹50,000 in a close-ended equity fund. Let’s take 2 situations here, one where you sell the funds in the stock market within 12 months another where you hold the funds for more than 12 months.

Scenario 1: Redemption within 12 months (Short-Term Capital Gains)

Let’s assume the value of the investment grows to ₹60,000. Your short-term capital gain (STCG) will be ₹60,000 - ₹50,000 = ₹10,000. Tax rate at 20% will be levied, which brings your tax payable to ₹2000.

Tax Payable: ₹10,000 × 20% = ₹2,000

Scenario 2: Redemption after 12 months (Long-Term Capital Gains)

Let’s assume the value of the investment grows to ₹70,000. Your long-term gains (LTCG) will be ₹70,000 - ₹50,000 = ₹20,000. Since you receive an exemption of 1,25,000 in this case. Your tax payable will be ₹0.

For closed-ended Debt Fund

Similar to the above example, let’s assume you invested ₹50,000. Here your tax liability will vary depending on the date you invested in the fund. Let’s understand both:

Scenario 1: Investments made on or after April 1, 2023

Taxation is based on your income tax slab, irrespective of the holding period. Assuming your investments grow to ₹55,000. Your capital gain will be ₹5000 (₹55,000 - ₹50,000). Total tax payable on this gain would depend on your income tax slab rate. So for instance if you come under the 30% bracket, this is how much tax you’ll have to pay on this investment.

Tax Payable: ₹5,000 × 30% = ₹1,500

Scenario 2: Investments made before April 1, 2023

Redemption within 24 months (Short-term):
Assuming you gained ₹5000 from this investment. You’ll be taxed at your income tax rate. Taking 30% as a reference, this will be your tax liability:

Tax Payable: ₹5,000 × 30% = ₹1,500

Redemption after 24 months (Long-term):
In this case your gains will be taxed at 12.5% (with no indexation benefit). Assuming the value grows to ₹60,000. Your capital gain comes to ₹10,000 (₹60,000 - 50,000). The total tax payable on your investment would now be:

Tax Payable: ₹10,000 × 12.5% = ₹1,250

Frequently Asked Questions (FAQ)