Whenever the topic of equity mutual funds is voiced, on most occasions, open-end equity funds are the ones that are discussed. Their counterparts, closed-end equity funds, have rarely been the subject of discussion. As a result, investors don?t really know much about closed-end funds and with certain recent developments, understanding closed-end funds has now become imperative. This is because, as fallout of the abolishment of the entry load, there could be a spate of closed-end funds being introduced in the coming times.

Entry loads were the source of income for fund companies and distributors. Now, distributors will have to earn a fixed mutually decided amount from investors. And as far as fund companies are concerned, they will earn largely from the 2.5% annual expenses that are deducted from a fund?s corpus. The higher the corpus, the higher their earning. And hence, running a fund will be more viable if investors stay invested in it for long periods. One way to ensure that this happens is through closed-end funds.

However, for an investor, a closed-end fund is a completely different ball game. Unlike open-end funds, investments in a closed-end fund can be made only during the NFO period. Also, redemptions are not allowed in closed-end funds. Of course, an investor can exit the fund before the fixed tenure by selling his units on a stock exchange. But then, finding another interested investor would be quite a task and then too, the units would probably get sold at a discount only.

Apart from these two basic problems, closed-end funds have other issues as well. Firstly, you can?t invest in such a fund through SIPs, which is the best proven way of successful investments. A closed-end fund accepts investments only in lump sums and that too only during the NFO period, a time when the fund has no history. Past performance doesn?t guarantee future returns, but it is an important tool in gauging a fund. With a closed-end fund you don?t have that option.

If you choose to invest in a closed-end fund, you have to rely on the fund company?s overall performance. That would be a workable situation, but not an ideal one.

One interesting approach of making returns from closed-end funds is by buying them from stock exchanges. Such funds are generally listed on exchanges and mostly traded at discounts. Savvy investors can buy them gradually from the stock market, which provides a sort of an outperformance guarantee if held onto till maturity. If the fund is a well run large-cap one then the returns earned by this approach can be truly exceptional. I personally know some investors who have employed this strategy by buying closed-end funds from the markets at 20-35% discount.

However, such approaches are middle paths that shouldn?t be treaded upon, especially when it?s your money that?s on the line. I expect fund companies to come out with closed-end fund more now that the entry load has been abolished. This is a rather adverse after effect of a positive move, and investors should be cautious. Closed-end funds are just not that good an option compared to open-end ones.

?Author is CEO of Value Research