Open-ended vs Close-ended Mutual Funds
Today, when we talk about mutual funds in India, it is predominantly about open ended mutual funds. These open end funds allow free entry and exit in the form of purchases and redemptions on all working days. Open ended and closed ended funds are about the freedom of entry and exit. Normally, closed ended funds are listed and the only liquidity in these closed ended funds is through the stock market mechanism.
In this section let us look in detail at what is close ended mutual fund and also understand the concept of what are open ended funds. We also look at the key areas of similarities and differences between open ended funds and closed ended funds. Of course, for starters, you can start taking the historical perspective by visiting some of the mutual fund analytics websites and making a note of the best open ended mutual funds by performance.
Table of Content
What are Open-ended Mutual Funds?
The open ended funds offer continuous investment and redemptions at NAV linked prices. Open ended funds are the most popular category in India as they do not entail any lock-in period making them a liquid form of investment. Unlike the closed ended fund where the AUM is normally capped at the initial level in terms of units, in open ended funds, there is continuous issue and redemption of units. As long as the net issue is positive, the overall AUM in terms of units keeps increasing. Open ended funds are not listed on the exchanges, so there is no risk of funds quoting at discount to NAV.
What are Close-ended Mutual Funds?
In the close-ended mutual funds scheme where your mutual fund investment is locked in for a specified period of time. This mutual fund can be for a shorter tenure or it can be for a longer tenure. You get the chance to subscribe to the close ended schemes only during the new fund offer period (NFO). Such closed ended units can only be redeemed once the tenure of the scheme is over. However there is an exit option in the form of listing, since all closed ended funds have to be mandatorily listed on the stock exchanges. Many closed ended funds behave like interval funds which mean they are closed ended for a period of time and then become open ended.
How Open Ended Funds Differ From Closed Ended Funds?
Here are some basic points on which open ended funds can be distinguished from closed ended funds.
a) The first difference pertains to liquidity. While open ended funds offer high liquidity at NAV linked prices, closed ended funds have limited liquidity in the secondary markets. Even if there is secondary market liquidity, the closed ended funds normally tend to trade at a discount to the NAV, entailing a huge cost to the investor. In the case of open ended funds, only ELSS funds are locked in for 3 years.
b) Open ended funds are amenable to lumpsum investing as well as SIP investing. On the other hand, closed ended funds can only be invested in the NFO or after the closed ended fund converts to an open ended. SIPs are not permitted in the case of closed ended funds. Since open ended funds are also amenable to systematic investment plans (SIPs), they give added benefit of rupee cost averaging.
c) It is much easier to measure the performance of the open ended fund since NAV details on a daily basis and portfolio details on a monthly basis are available in a transparent manner. On the other hand, the information regarding the performance of a closed ended fund is a lot more opaque.
d) The entry barriers to invest in an open ended fund are much lower. For instance, in an ongoing open ended fund, you can make a minimum investment of Rs1,000 and if it is a SIP, it can go as low as Rs500 per month. However, closed ended funds are only open in the event of an NFO where Rs5,000 is the minimum investment involved.
To sum it up, open-ended funds are preferred and also suggested by advisors due to their simplicity, liquidity and transparency.
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Frequently Asked Questions
Open-ended mutual funds allow multiple investors to pool money and invest in a diversified portfolio of securities, including stocks, bonds, or a combination of both. Professional fund managers manage the fund and make investment decisions on behalf of investors.
A closed ended fund is a fixed number of units issued at launch, which cannot be purchased or redeemed after the NFO period. They are traded in the market and have a fixed maturity period.
The close ended mutual fund works as the brokers facilitate the purchase and sale of units in closed-ended funds, which often trade at a discount to their underlying asset value and have a fixed maturity period.
Mutual funds are suitable for investors depending on their financial goals, risk tolerance, and investment time horizon. However, investors need to assess their objectives and understand the risks associated with mutual funds. Whether investing or open ended and close ended mutual funds, it all depends upon your investment goals.
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