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Never Invest In The 'Close-ended' Equity Scheme NFOs

NOT scared of the sharp ups and downs in the stock market?
You can skip the ‘close-ended’ equity mutual funds / ELSS schemes.

Scared of the sharp ups and downs in the stock market?
Even then you SHOULD skip the 'close-ended' equity mutual funds / ELSS schemes. (In fact, you should not invest in equity at all.)

In short, no one should invest in the close-ended equity-oriented funds!

Because, (practically) everything is wrong about such close-ended funds:

Why?

1. Because, being a new fund offer, the close-ended fund has no history
Past performance is one of the most important criteria to assess, before investing in any mutual fund scheme. You can invest in a close-ended fund only at the time of its New Fund Offer (NFO). At this stage, it has no history, no performance track record. Therefore, investing in an UNPROVEN scheme is a bad idea indeed. More so when you have many (many) open-ended equity schemes — with excellent track record — to choose from.

2.  Because, being a new fund offer, there is no portfolio as yet
Another key parameter to evaluate is the scheme’s portfolio i.e. the stocks / market segments where the corpus is invested. This helps you to decide whether it is a mere duplication of the funds that you already own. Or, will it add value to your portfolio. Therefore, investing in an UNKNOWN scheme is a bad idea indeed. More so when you have many (many) open-ended equity schemes — with a known portfolio — to choose from.

3.  Because, being a one-time investment option, you cannot do SIP
It is a well proven fact that investing lump sum amount — on one-time basis — in the equities is extremely risky. One of the best strategies to minimize the risk of stock market volatility is to invest small sums of money at regular intervals… known as Systematic Investment Plan or SIP in mutual fund parlance. Therefore, investing on a ONE-TIME basis in a closed-ended fund is a bad idea indeed. More so when you have many (many) excellent open-ended equity schemes — where SIPs can be conveniently started (and stopped, if need be).

close-ended-mutual-funds
Don't get trapped in a Close-ended Equity-based New Fund Offers.

4.  Because, being close-ended in nature, you lose liquidity
In close-ended funds you cannot withdraw your money before the maturity date. It’s true that you should stay invested for long term in equity funds. Therefore, if your money is locked-in in a close-ended equity scheme, it is not such a serious drawback.  However, open-ended schemes offer anytime liquidity without compromising your investment in any manner whatsoever. Therefore, NEEDLESSLY locking-in your money is a bad idea indeed.

5.  Because, being close-ended in nature, you cannot book profits or cut losses
In close-ended funds you cannot withdraw your money before the maturity date. So if the scheme is an under-performer, you have no option but to stick with a poorly performing fund. You cannot cut your losses and switch to a better fund. Similarly, if you wish to book profits to rebalance your portfolio, you cannot do so. Open-ended schemes offer instant redemption without compromising your investment in any manner whatsoever. Therefore, LOSS OF FLEXIBILITY over your investment is a bad idea indeed.

Must Read: Vidya Balan or Angelina Jolie, who is a better actress.

Give these serious drawbacks in close-ended funds, three questions arise:
a. Why do investors risk their hard-earned money in such schemes?
b. Why do mutual fund companies frequently launch close-ended equity new fund offers?
c. What is the logic given by the mutual fund companies / distributors?

Let’s explore:

Why do investors risk their hard-earned money in such schemes?
In New Fund Offers the investment happens at the NAV of Rs.10. In existing open-ended schemes the NAV could be in 100s or even 1000s. 

Many people believe that Rs.10 NAV fund is cheaper than a Rs.100 or Rs.1000 NAV fund. Hence, they prefer to invest in low NAV funds vis-à-vis the high NAV ones.

However, this belief is completely baseless, untrue and wrong. The FACT is that NAV has ABSOLUTELY NO ROLE in how much profit a scheme will generate. Unfortunately, despite being in existence for more than two decades, this myth about low or high NAV continues to prevail.

This is one among the many shocking mistakes mutual fund investors often commit.

Why do mutual fund companies frequently launch close-ended equity new fund offers?
As discussed earlier, investors are reluctant to invest in existing schemes due to so-called high NAV. Therefore, mutual fund companies are forced to offer Rs.10 NAV New Fund Offers to attract money from the investors. So partly, it is the people’s fault for this unhealthy practice.

There is another reason for mutual fund companies launching close-ended NFOs. And that’s… commission.

In a close-ended scheme, the mutual fund companies are sure that the corpus raised will remain with them for the given period. This enables them to offer higher commission to the distributors as compared to the open-ended schemes. Naturally, therefore, distributors tend to focus more on selling close-ended funds and not the open-ended schemes. Their interest is in their commission and not the problems that the investor will face in a close-ended fund.

What is the logic given by the mutual fund companies / distributors?
One argument is that the fund manager can take a long term view on stock selection. S/he does not have to worry about short term performance. Nor is there any threat of redemption. So s/he need not keep high cash balance.

Well, the simple answer to this is again the same — there are many open-ended equity schemes delivering excellent returns despite the pressures of redemption and short-term performance. So why should one willingly suffer the problems of a close-ended fund?

The other argument is that in case of extreme market corrections, people would be protected from their own emotions. Despite the obvious panic, they would not be able to redeem their investment. Thus, they would be prevented from taking any hasty and wrong decisions.

This is the only — I repeat, only — benefit of investing in a close-ended scheme.

However, given the many disadvantages, this one small positive point in favour of close-ended funds can safely be overlooked and ignored.

Hence, when it comes to investing in the close-ended equity-oriented / ELSS funds, just one word would suffice — AVOID.

Note: Close-ended debt funds are fine. Most of the issues pertaining to the equity-based funds DO NOT apply to debt funds. Thus  if liquidity is not your concern  you can surely invest in close-ended debt-based new fund offers.

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