Contents
- Open-Ended Mutual Fund
- Advantages of Open-Ended Funds
- Liquidity
- Availability of track record
- Systematic Investment Plan
- Disadvantages of Open-Ended Funds
- Suffers from Market Risk
- No say in asset composition
- Closed-Ended Mutual Funds
- Advantages of Closed Ended Mutual Funds
- Stable Asset Base
- Availability of Market Prices
- Liquidity and Flexibility
- Disadvantages of Closed Ended Mutual Funds
- Poor Performance
- Lump-Sum Investment
- Non-Availability of Track Record
- Comparative Analysis of Closed-Ended and Open-Ended Mutual Funds
- BASIS
- OPEN-ENDED MUTUAL FUNDS
- CLOSED-ENDED MUTUAL FUNDS
- Meaning
- Entry & Exit
- Availability
- Price Determination
- Management Style
- Maturity Period
- Publishing of NAV
- Profits
- Corpus
- Selling Price
- Trading
- Restrictions
- Minimum Investment
- Liquidity
- Comparison Between Open-Ended and Closed-Ended Mutual Funds
- Conclusion
Mutual funds are categorized according to various characteristics, such as the nature of the investment, risk profile and investment philosophy. Apart from these, the funds are distinguished based on their structure – open-ended and closed ended mutual funds. The difference between the two depends on the flexibility of the sale and purchase of fund units.
Open-Ended Mutual Fund
Open-ended funds are mutual funds. These funds do not trade in the open market. They don’t have a limit as to how many units they can issue. The NAV varies daily because of market inconstancies of the shares or stocks and bond prices in the fund. Open-ended mutual fund units are bought and sold on request at their Net Asset Value or NAV which is reliant on the value of the fund’s underlying securities and is expected at the end of every trading day. Investors buy units directly from a fund. The investments of the open-ended fund are valued at the clear market value which is also the closing market value of listed public securities. These funds do not have a fixed maturity period.
Advantages of Open-Ended Funds
Liquidity
Open-ended funds give high liquidity because you can redeem units of the fund as per your preference. Compared to other types of long-term investments, open-ended funds offer the flexibility of redemption at the prevailing Net Asset Value (NAV).
Availability of track record
In the case of closed-ended mutual funds, you are not able to see the performance of the fund over different market cycles on account of the non-availability of track record. However, in the case of open-ended funds, the historical performance of the fund is available. Consequently, investing in an open-ended fund is a well-informed choice.
Systematic Investment Plan
Closed-ended mutual funds want you to invest a lump sum to buy the units of the fund at the time of their launch. This can be certainly a risky approach to deal with your investments. It reveals you to take bigger risks than otherwise warranted. Nevertheless, open-ended funds is a suitable investment option for a large number of salaried class of investors. It is because they can start Systematic Investment Plans (SIP) into the fund of their choice.
Disadvantages of Open-Ended Funds
Suffers from Market Risk
Even though the fund manager of open-ended funds operates a highly diversified portfolio, they suffer from market risks. The NAV of the fund keeps fluctuating according to the movements of the underlying benchmark.
No say in asset composition
Open-ended funds designate fund managers who are well-qualified and have knowledge in the field of fund management. They take all the decisions as regards the selection of securities for the fund. Hence, the investors do not have a say in deciding the asset composition of the fund.
Closed-Ended Mutual Funds
The closed-ended mutual fund issues a fixed number of units that are traded on the stock exchange. It works much more like an exchange-traded fund than a mutual fund. They are launched via NFO to accumulate money and then traded in the open market just like a stock. Though the value of the fund is based on the NAV, the actual price of the fund is affected by supply and demand as it is permitted to trade by prices above or below its actual or real value. Consequently, closed-ended mutual funds can trade at premiums or discounts to their NAVs. Units of closed-ended mutual funds are bought and sold by brokers. Closed-ended mutual funds normally trade at discounts to their underlying asset value. These funds have a fixed maturity period.
Advantages of Closed Ended Mutual Funds
Stable Asset Base
In Closed-ended mutual funds, the investors are not permitted to redeem units of the fund except in the prescribed dates i.e. when the maturity of the fund expires. In this way, portfolio managers get a firm base of assets that is not subject to frequent redemptions. The main benefit of a stable asset base is that the fund manager is in a suitable position to formulate an investment strategy keeping in mind fund objectives holistically and without having to worry about the inflows and outflows.
Availability of Market Prices
Closed-ended mutual funds trade on stock exchanges like equity shares. This allows the investors to buy/sell units of the fund based on real-time prices which can be above (premium) or below (discount) the fund’s NAV. They can obtain the use of usual stock trading strategies like market/limit orders and margin trading.
Liquidity and Flexibility
Investors are free to avail of liquidity offered by the fund. They may use real-time prices available during the trading day to buy/sell closed-ended mutual funds units at prevailing market prices. They get the flexibility to select their investments by utilizing real-time information.
Disadvantages of Closed Ended Mutual Funds
Poor Performance
Performance of the Closed-ended mutual funds has not been at par as compared to their open-ended peers across time horizons. You may know that the fund manager is in a favorable position due to restrictions on redemptions. The lock-in period levied in closed-ended mutual funds which are aimed at giving the fund managers the flexibility to allocate the money without the fear of outflows has not helped much in generating better returns.
Lump-Sum Investment
Closed-ended mutual funds want you to invest a lump sum to purchase the units of the fund at the time of their launch. This can be certainly a risky approach to deal with your investments. It opens you to take bigger risks than otherwise warranted. Furthermore, a large number of salaried class of investors are unable to afford lump sum investments. Instead, they prefer staggered investments by way of Systematic Investment Plans (SIP).
Non-Availability of Track Record
In the case of an open-ended fund, you can see the performance of the fund over different market cycles on account of the availability of historical data. However, in the case of closed-ended funds, the track record is not available. Hence, investing in a closed-ended fund is filled with uncertainties and you can only depend on the fund manager.
Comparative Analysis of Closed-Ended and Open-Ended Mutual Funds
BASIS | OPEN-ENDED MUTUAL FUNDS | CLOSED-ENDED MUTUAL FUNDS |
|---|---|---|
Meaning | Continuous buying and selling of the units | Capital is fixed selling a specific number of units. |
Entry & Exit | Convenience as per the investors | Participation only till the NFO (New Fund Offer) is on |
Availability | Funds are not traded in the open market and get repriced based on the number of shares bought and sold. Transactions are performed directly through the fund. | These funds are launched through an IPO for raising money and consequently listed like a stock or an ETF. |
Price Determination | The NAV per share is arrived at by dividing the Total Net assets by the number of outstanding shares. Any additional expenses have to be reduced from the total assets. | The value is based on the NAV but the actual price is determined by the demand and supply making it possible to trade at prices above or below the value of its holdings. |
Management Style | It can be active, passive or a combination depending on circumstances. | It follows an Active style of management. |
Maturity Period | No Fixed maturity | Fixed maturity period which can normally range from 2-5 years. |
Publishing of NAV | Published on a Daily basis | Published on a weekly basis |
Profits | Profits depend upon the investors and when they exit the fund. If they have exceeded their starting investment, then it is considered as a Gain. | Profits to the shareholders can be in the form of income and capital gain distributions. It can also be capital gains realized from the sale of shares with increasing share value though it is exposed to tax liability. |
Corpus | It depends on the confidence of the investors. | It remains fixed as new units are not issued. |
Selling Price | NAV plus entry or exit load as defined in the Prospectus | Traded at Premiums or Discounts to their NAV’s |
Trading | Purchased directly from the underwriter of the fund | Bought and sold through brokers. Brokerage firms underwrite and sell newly-issued shares |
Restrictions | Reasonable restrictions on investment in Leverage & Liquidity due to high levels of volatility and risks involved. | Fewer restrictions with respect to leverage and liquidity but strict regulatory limits would be applicable. |
Minimum Investment | Smaller investment which is engaging to retail investors with limited disposable money. | Lump-sum investment is permitted. |
Liquidity | Investments can be easily liquidated | Investments are shifted towards illiquid securities that cannot get traded at the NAV within 7 days. |
There is a huge difference between open-ended and closed-ended mutual funds which can be clearly seen in the table.
Comparison Between Open-Ended and Closed-Ended Mutual Funds
- Some open-ended fund investors are fast to redeem their units after the NAV appreciates by 5%–10% to book short-term profits. This disturbs the investors who remain invested in the funds. Closed-ended funds are more suitable options in such conditions because the lock-in period prevents early redemption and protects the interest of long-term investors.
- Open-ended funds can be beneficial for someone who has less or no information about the markets and desires an annualized return of 15%–20%. As these funds are managed by professionals and experts, with the NAV being updated daily and highly liquid these get slightly more beneficial for investors than the closed-ended funds.
Conclusion
It is difficult to answer whether open-ended funds are more reliable than closed-ended funds or vice versa. The performance of a fund whether open-ended or closed-ended depends on the fund category, investment style, and fund management. Despite each of the categories having its pros and cons, the decision to make the investment rests in the hands of the investors and their investment objectives. It also depends on the risk appetite of the investor. A retail investor with a limited amount of capital will prefer an open-ended fund as it offers a lot of flexibility with relatively stable returns.
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