People often criticize closed-ended funds on the grounds that these schemes charge higher expense costs to investors than the open-ended funds. This is not true. Fund industry officials say that it’s a fact that closed-ended funds charge the expense ratio in one shot soon after subscription closes, but then it does not incur any marketing costs. Also, since the marketing for the fund is done only once, the higher expense ratio, which mutual fund schemes are allowed to charge for taking schemes beyond the top 15 cities (B-15 — in industry parlance), is not charged every year.

In contrast, open-ended funds charge that extra amount — which could be up to 30 basis points in some cases for mutual fund schemes — every year. So, after the end of the first year, in case of schemes managing large amounts of money. the charges for closed-ended schemes could in some cases be even lower than open-ended funds of similar sizes. But for most closed-ended funds, the charges are similar to open-ended funds of similar sizes.

Industry officials say that any comparison between an open-ended and a closed-ended scheme should be on an equal scale. According to these officials, the cost structure, however, could tilt in favour of open-ended funds in case the comparison is be tween, say, a closed-ended fund of Rs 1,000-crore size and an open-ended one of, say, Rs 5,000 crore. Also, if a closed-ended fund is of a size that’s Rs 50-60 crore, then also the costs would be higher than an open-ended fund of a similar size.

Some people also criticize the fact that closed-ended funds lack liquidity. This is true. Once you have invested in a closed-ended fund, there is very little chance of you getting an exit earlier than the closure of the fund although all these funds are listed on the bourses. However, the fact remains that when investors come into these funds, they come in knowing fully well that they are unlikely to get an option to redeem their money before the end date of the fund. Also, being in a closed-ended structure, there is homogeneity in investment horizon of investors and the fund manager.

The low liquidity aspect also prompts comments like, even if the market is up by 40-50% in a year or so, the investors are unable to book profits. Here, the issue is equity mutual funds are long term investments. So, even if one witnesses a 40-50% appreciation in a year or so, the question is why should he she cash out in such a short duration?

Also, even if the fund has given a return of 40-50% in such a short term, what is the guarantee than it won’t go up by an equal percentage or even more in the remaining time horizon to its closure?

By taking money out early, one may even miss out on bigger gains.

The low liquidity and a closed-ended structure also guarantees that, in case someone is carried away by emotion in the face of a high return at a short notice and wants to redeem, the structure will deter him/her from doing that.