How to pick closed-end equity funds

With at least four closed-end equity scheme launches in the market now, there is a fair choice if you want to invest. These funds have seen increased number of launches over the last 3-3.5 years. As per data from Association of Mutual Funds in India (Amfi), the total assets under management (AUM) for closed-end schemes at Rs1.81 trillion (March 2017) are around 11% of the AUM for open ended schemes. Only 14% of the closed-end basket comprises equity funds. Unlike their open-ended peers, in closed end funds you must remain invested till the end of the pre-defined investment period. Here are few things to look out for before choosing a closed-end scheme. 

Performance: There is no performance track record. Hence, track fund manager ‘s performance. A comparative return analysis done a few months ago by Mint Money (read here) showed that as a category closed-end funds were unable to outperform open-ended funds in a 2-year period. Currently, 1-year returns in the broad closed-end equity category range from about 10% to 35%. Thus, picking the fund manager is important. Timing of launch too matters, as no fresh inflows come in through the life of the scheme and it is not certain that the scheme will be continued beyond its tenure. Check asset allocation: some schemes limits downside when market returns are negative in the fixed period. 

Theme: There are many thematic closed-end funds. The recent launches talk about stock selection driven by earnings impact, because of recent economic reforms including the implementation of Goods and Services Tax. Thematic funds can be high risk as they focus on one segment of the market. If it does not work out, the fund manager will not be able to balance with stocks from other sectors. 

Size: You cannot know the fund size beforehand. Watch out for the expense ratio, which may be relatively higher at around 3% per annum for smaller-sized funds. Majority of the existing closed-end funds have an expense ratio of above 2.5% per annum. 

Dividends: Investing in these funds for the sake of earning dividends is not wise. The amount of dividend payout cannot be known in advance, given that the nature of investment is volatile (equity), while the scheme is of a fixed duration. 

Discipline: Closed-end funds may prove useful if you lack the discipline to remain invested and panic at the slightest negative news that impacts equity value. You will be forced to remain invested through ups and downs and with a good fund manager, return objective might be achieved in a short (for equity investing) 3-year period.