What Is a Closed Fund?
A closed fund is a fund that is either closed toinvestors (temporarily or permanently) or has ceased to exist. Funds can close for various reasons, butprimarily they close because the investment advisor has determined that the fund's asset base is getting too large to effectively execute its investing style. A fund can cease to exist if it fails to perform and investors withdraw their funds.
A closed mutual fund should not be confused with a closed-end fund, whichhas a fixed number of shares, generally invests in specialized sectors, and trades like a stock on a stock exchange.
Key Takeaways
- A closed fund is one that has stopped accepting new money from investors.
- A fund closed to new investments may be winding down and terminating, or else has reached some specified amount of assets that precludes it from taking in more money.
- Some investment strategies stop being profitable if the positions taken in them become too large.
- If the fund continues to operate, while it will not accept new client money, it will continue to manage its portfolio according to its mandate.
Understanding a Closed Fund
A closed fund may stop new investment either temporarily or permanently. Closed funds may allow no new investments or they may be closed only to new investors, allowing current investors to continue to buy more shares. Some funds may provide notice that they are liquidating or merging.
When a fund announces it is closing, it may be structured in various ways. The fund company can close to new investors only or stop allowing new investments from any investors.
If a fund plans to remain in operation, the fund will continue to manage operations normally. Existing investors have the advantage of owning shares and benefiting from further income and capital appreciation. Current investors are often given priority when a fund begins limiting its asset inflows. Thus it may reopen only to currentinvestors first before allowing additional investments again.
Special Considerations
In some cases, a fund may be liquidating following the announcement of a closing. If a fund is liquidating, the management investment company will sell all of the assets in the fund following a predetermined schedule. The fund company will then provide investors with the proceeds. Fund companies may also merge shares of a fund with another existing fund.
Fund companies will provide investors with notice of liquidation or merger. If the company distributes a payout to investors due to a fund closing, the investors will be liable for tax implications. Companies may provide investors with reinvestment options in other affiliated funds, which can avoid taxes for the investor.
Money managersmay close certain portfolio groups to new accounts (such as those with less than $10,000 to invest), while leaving others open to specific types of investors, such as institutional investors.
Factors Leading to a Closed Fund
If a company is liquidating or merging fund shares, it is typically due to a lack of demand. If inflows have been decreasing, or if demand for a new fund has not generated enough inflow to keep it active, then a fund company will take action to liquidate or merge the shares into a fund with a similar objective.
Sometimes, a fund may need to close because of asset bloat, which can occur from excessive inflows to a fund. This is most common when a fund invests in small-cap stocks or a small number of securities. With these funds, an excessive inflow of capital can significantly affect the market and the targeted stocks in the portfolio.
Funds that close due to asset bloat will usually be actively managed funds, since passive indexing strategies are immune to this issue.
Funds may need to close for other reasons, such as compliance with the 75-5-10 rule for diversified funds. The 75-5-10 rule is outlined in the Investment Company Act of 1940. The rule states that a fund can have no more than 5% of assets in any one company and no more than 10% ownership of any company's outstanding voting stock. Diversified funds must also have 75% of assets invested in other issuers and cash.
Overall, fund closings are on a case-by-case basis, and each fund will have its own individual reasons for closing. If a fund is only closing temporarily, then both current and potential fund investors can seek to understand the specific parameters of the closing and when it may be opening again.
