Close-ended schemes

Close-ended schemes

Closed-end funds are ideal for adding and diversifying existing core bonds and stock holdings. Whether a scheme is closed-ended or open-ended, its success is influenced by the fund management, category, and investing approach. After the NAV increases by 5–10%, many investors in open-ended schemes generally act quickly to redeem their units and take their gains. This impacts investors who have money in the plan. As the lock-in period restricts early redemption and safeguards the interests of all investors, close-ended mutual funds are a superior choice in these circumstances.  

What are close-ended schemes? 

Close-ended schemes are an investment vehicle that allows investors to purchase a fixed number of shares during an initial offering period. Once this period ends, the number of shares in the scheme remains fixed, and investors can only buy or sell shares on the secondary market. These schemes are popular among investors who want to invest in a specific asset class or strategy but avoid being exposed to market fluctuations. Currently, there are about 480 close-ended funds available for trading on US stock exchanges. 

Understanding close-ended schemes 

A new fund offer (NFO) is created by an asset management company (AMC), and investors buy units of the scheme at a set price. There is no more room for new investors when the NFO period has ended. In addition, investors can withdraw their money once the plan is fully developed. When a plan reaches maturity, it is dissolved, and investors receive their money back at the NAV (net asset value) in effect on that day. 

Unlike exchange-traded funds (ETFs) or mutual funds, close-ended funds allow outside investors to purchase and sell shares. A close-ended fund’s management does not issue and buy back shares. 

Most close-ended funds are listed on the NYSE or Nasdaq, trading actively until the fund achieves its goal, liquidates itself, and distributes investor wealth. 

 

Features of close-ended schemes 

  • One of the key features of close-ended schemes is that they offer investors a specified investment horizon. This means that investors know exactly when to expect to receive their principal and any returns.  
  • Close-ended funds must abide by SEC regulations since they have registered with the SEC. Additionally, the close-ended funds’ investment portfolios are often managed by independent organisations known as investment advisors who are also SEC-registered. 
  • Close-ended schemes can also give investors access to unique investment opportunities that aren’t available through other investment vehicles. For example, some close-ended schemes invest in private equity or real estate, which can be difficult for individual investors to access independently. 

Advantages of close-ended schemes 

  • Close-ended funds have steady valuations of assets and a steady cash flow.  
  • These funds trade on stock markets much like equity shares. As a result, investors can buy and trade the units instantly. Market prices may be lower or higher than the fund’s NAV. They can also use margin trading, market or limit orders, and other stock trading tactics. 
  • Based on anticipated profits, investors may budget their upcoming expenses. 
  • Close-ended funds allow the fund manager to build a unique portfolio with the potential to generate returns. Fund managers can investigate inexpensive debt and equity instruments that would not otherwise be included in the portfolio because of the lock-in period of close-ended schemes. 
  • These schemes are not eligible for redemption. However, while being listed on the stock market, it allows the investor the option to sell their shares. Consequently, it is simple to liquidate an investment. 

Examples of close-ended schemes 

The Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG) is one of the biggest close-ended funds. It was established in 2007. 

Another example is the announcement made by the close-ended investment firms Cornerstone Strategic Value Fund and Cornerstone Total Return Fund. 

Frequently Asked Questions

Close-ended schemes can only be purchased during the NFO period, and the units can only be redeemed after the scheme’s tenure (lock-in term), or NFO has passed. 

 

Compared to open-ended funds, which may be purchased or sold anytime, close-ended funds can only be bought at their introduction and must be redeemed after the fund’s investing period. An open-ended fund is a much better choice since you may invest in it whenever you like using the surpluses you have on hand and because it is extremely liquid because it can be redeemed at any moment. 

A lump sum investment is required for close-ended funds, with no early redemption possibility. Therefore, close-ended mutual funds are an option for investors with investable capital and an investment objective that coincides with the scheme’s maturity date. This means that individual investors hold the majority of close-ended funds. Most of these investors prefer to liquidate their assets during down markets. This widens the discount to the net asset value of close-ended funds. Opportunities exist for investors to acquire close-ended funds at bigger than normal discounts. 

Close-ended schemes have the following disadvantages: 

  • Close-ended funds don’t have a track record of performance. 
  • Close-ended funds do not provide the SIP, STP, or SWP features for systematic investments, transfers, or withdrawals. 
  • Close-ended funds have relatively little liquidity.  
  • Only brokers are permitted to purchase or sell shares. 
  • There is always a pricing risk. 
  • The NAV and share price never match. 

 

In the US, taxation of close-ended schemes follows a specific set of rules and regulations. Firstly, it is important to understand that close-ended schemes are investment funds with a predetermined number of shares issued through an initial public offering. These shares are then traded on an exchange, and their values are determined by market demand. Additionally, investors may be subject to taxes on any income the close-ended scheme generates, such as through dividends or interest payments.  

 

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