What is Closed to New Investors
Closed to new investors means a fund has decided to stop allowing new investments from any investors who are not already invested in the fund. Mutual funds and hedge funds may choose to close to new investors for various reasons.
BREAKING DOWN Closed to New Investors
Closing to new investors is one scenario a fund can use to manage its operational activities when issues occur with the fund. Closed funds may also stop taking investments from current investors as well. Funds may or may not provide details of the closing specifics when they decide to close to certain investors. The decision to close a fund to new investors is not an easy one to make, since the fund is potentially giving up a significant amount of management fee income.
Funds generally close for one of two reasons. The fund may be closing due to low performance or low demand. Inversely, the fund may be receiving substantial demand with excessive inflows. If a fund is only closing to new investors, it is likely the fund is seeking to minimize its inflows while still operating actively.
Excessive fund inflows can be a factor for several reasons. They can cause asset bloat which makes it challenging for managers to make investments in line with the fund’s strategy. This can lead to higher cash levels and inefficient management of capital. Closed funds can be common in actively managed strategies for this reason. Comparatively, passive funds will not be challenged by choosing assets and therefore are less susceptible to fund closings.
Another consideration that is important for portfolio managers, specifically in diversified funds, is the fund’s positioning in single stocks. Management investment companies registered under the Investment Company Act of 1940 can manage either diversified or non-diversified funds. Diversified funds have assets that fall within the 75-5-10 rule. This rule says that funds 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 follow 75-5-10 compliance closely and this rule can be a leading factor causing funds to limit their investments.
Typically closing to new investors is not a performance-related issue. Thus, current investors should not panic. If a fund does not provide full disclosure on the closing, current investors can request additional information. Oftentimes, closing to new investors is done to help the fund’s operational efficiency and improve its performance. Current investors should keep in mind that liquidating their entire investment in the fund can keep them from making new investments in the future. (See also: Closing Mutual Funds: Investment Protection or Trap?)