Ace the NISM Mutual Fund Distributors ExamDifficulty: BeginnerInfo   5 min read
📌 Chapter 12.3 — Scheme Selection based on investment strategy of mutual funds

Picture a client who calls you in a panic, needing to liquidate a portion of their portfolio to pay for an unforeseen medical emergency. You check their holdings and realize a significant chunk is locked in a close-ended equity scheme that still has eighteen months of tenure remaining. Unlike their open-ended liquid or balanced advantage funds, this capital cannot simply be redeemed with the Asset Management Company.

You must now guide them through the reality of selling units on the stock exchange, a process that is often fraught with low liquidity and price distortions.

Close-ended schemes are characterized by a fixed maturity date, meaning the AMC does not issue or redeem units on a continuous basis after the initial offer period. While these units are mandatorily listed on stock exchanges like the NSE or BSE to provide an exit route, the trading volume is frequently abysmal. An MFD must understand that the market price on the exchange is driven by demand and supply rather than the underlying Net Asset Value.

This leads to the phenomenon of trading at a discount or premium to the NAV, which can catch an unprepared investor by surprise.

For an MFD, recommending a close-ended product requires a precise suitability assessment regarding liquidity needs. If you suggest a close-ended fund for a client who might require their capital within the next three years, you are setting them up for a potential loss. If the market is bearish, the discount to NAV can widen, meaning your client might have to sell at a price significantly lower than what the portfolio is actually worth.

While the locked-in nature of these funds allows the fund manager to take long-term bets without worrying about redemption pressures, the burden of liquidity falls squarely on the investor’s shoulders when they seek an early exit.

Always explain that the exchange price is a secondary market reality, not an official valuation by the AMC. While your guidance and behavioral hand-holding through the life of the investment provide immense value, you cannot manufacture liquidity where none exists in the market. The best approach is to treat close-ended funds as ‘set and forget’ instruments that should only occupy a small portion of a portfolio, specifically reserved for funds that the client is certain they will not need until the maturity date.

Nuance

⚠️ Nuance
Candidates often confuse the ability to ’list’ a fund with the ability to ‘redeem’ it easily. They assume that because a fund is listed on the exchange, it functions like an equity share with high liquidity. In reality, most close-ended mutual fund units suffer from a lack of active buyers, meaning an investor may be unable to exit their position at the prevailing NAV even if they are willing to sell at a loss.

Check Your Understanding

Practice Question 1

Mr. Sharma holds units in a close-ended scheme and wishes to exit before the maturity date. He observes that the current market price on the NSE is significantly lower than the fund’s NAV. As an MFD, how should you explain this situation to him?

Practice Question 2

Which of the following is a primary reason why an MFD should exercise caution when recommending close-ended schemes to clients with uncertain financial goals?

This is a companion read for Section 12.3 — Scheme Selection based on investment strategy of mutual funds from Ace the NISM Mutual Fund Distributors Exam by Akhilesh Gururani, available on Amazon Kindle.

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