Investment in mutual funds is a method whereby an investor can invest in the securities market. Investors can get exposure to debt and equity-related securities. One has to understand the structure of funds before investing. Mutual funds can be categorized into three types based on their structure, i.e. open ended funds, close ended funds and interval funds. Of these, open ended mutual funds are the most common among investors.
Here, in this article, we will understand the open ended mutual funds along with their benefits and limitations.
What are open ended funds?
Usually, every mutual fund is launched through a New Fund Offer (NFO). Hence, if an investor applies for an NFO, the fund units are allotted at the NFO price. However, after the NFO ends, the mutual fund is launched as an open ended fund. By investing in an open ended mutual fund, it allows investors to enter and exit the fund anytime. On the other hand, close ended mutual funds do not allow investors to enter or exit after the NFO period. The investor has to stay until the maturity period of the fund.
In open ended mutual funds, the NAV changes daily based on due to the stock market movement and changes in the bond prices. Investors can choose to buy any fund at its Net Asset Value NAV. The NAV or Net Asset Value of the fund is determined on the performance of funds underlying securities. Investors can purchase and redeem units from the fund house at the existing NAV of the scheme.In other words, Open ended mutual funds are available for purchase and redemption on all working days.
A fund manager is assigned to every fund. They manage the fund investments and invest in securities for the fund portfolio. Thus, these funds are subject to expense ratio due to the fund management charge involved.
Also, these funds are highly liquid as the funds are not bound to any maturity period.
There is another thing to understand about these funds. When an investor buys units (invests in a fund), the number of units of the fund increases with the investment. Similarly, when an investor sells units(redeems from a fund), the number of units of the fund reduces. These funds see an increase in their AUM. This is due to the rise in market prices and the number of outstanding units increasing.
The majority of mutual funds in India and around the world are open ended mutual fund schemes.
Types of open ended mutual fund
The following are the types of mutual funds which are categorised based on their structure, asset class, speciality, etc.
The categorization of mutual funds based on the asset class
Following are different types of equity mutual funds
- Multi cap fund
- Large cap fund
- Large and mid cap fund
- Mid cap fund
- Small cap fund
- Value fund
- Contra fund
- Sectoral fund/ thematic fund
- Equity linked saving scheme
Following are different types of Debt mutual funds
- Overnight fund
- Liquid fund
- Ultra short duration fund
- Money market fund
- Short duration fund
- Medium duration fund
- Long duration fund
- Dynamic bond fund
- Corporate bond fund
- Credit risk fund
- Banking and PSU fund
- Balanced fund/ hybrid fund
The categorization of mutual funds based on their speciality
- Index funds
- Fund of funds
- Commodity funds/ hedge fund
- Asset allocation funds
- Retirement funds
- Children funds
Advantages of investing in open ended funds
The following are the benefits of investing in open ended mutual funds.
Investors can redeem the units from this fund anytime based on their requirement and convenience. In comparison to other long term investments, there is a flexibility of redeeming funds. The funds of the open ended scheme are redeemed at current Net Asset Value NAV. This adds a necessary component of liquidity to the investor’s portfolio.
Availability of historical performance
Unlike a close ended fund, one can view the historical performance of the open ended fund. It offers a quick glimpse of the past performance of the fund across different market cycles. The past performance report consists of annual returns, trailing returns, rolling returns and many more. Thus, it helps an investor for a wise investment decision.
Availability of Systematic options
Open ended mutual funds offer investors to use systematic plans for making investments and withdrawals. The investor can choose to set up SIP, SWP and STP based on their requirement. SIPs are ideal for salaried class investors or people without an investible surplus in their hand. Also, investing through SIP helps in building a corpus from scratch. Comparatively, close ended funds do not have any of the systematic options.
One can also use Scripbox’s SIP calculator for calculating the SIP returns.
There is a wide range of assets in the open ended funds in India. Some of the assets classes include debt, equity, index funds, ETF funds, etc. This helps the investors to build a diversified portfolio based on their financial plan and investment objective. Diversifying the portfolio reduces the chances of risk overall.
A fund manager actively manages every mutual fund. These fund managers have expertise, experience, knowledge and resources to make the right investment decision for investors. This also helps the investors to get exposure in the market under professional guidance.
Comparatively, these funds offer substantial returns and capital appreciation to other investment schemes. It is suitable for investors to meet their long term and short term financial requirements based on their investment planning objectives.
Open ended mutual funds do not trade on the stock market. The purchasing and selling of shares are directly from the fund company. Hence, there are no mediators involved. The investors have complete transparency about their investment portfolio in mutual funds.
Limitations of investing in open ended funds
The following are the limitations of investing in open ended funds.
Even though a fund manager actively manages the open ended mutual fund, they still experience market risk. The Net asset value of the fund fluctuates daily based on its underlying securities. However, the fund manager endeavours to contain the volatility by diversifying the investments. Hence, open ended mutual funds are prone to market risk and highly volatile.
Sometimes, the liquidity offered by mutual funds can also be a disadvantage. The investors can purchase and sell units anytime and creates a room for risk. Since there is no lock-in period, investors wish to redeem funds when there are good returns. Also, some investors are tempted to invest more in the bull market and may redeem units during volatility.
Most open ended funds have exit loads. There are certain charges levied while exiting the fund, typically within one year. Thus, the earnings from the fund reduce. It also attracts capital gains tax for individual investors.
The reason to maintain a cash reserve is that the fund manager cannot sell securities immediately in case of massive redemptions. Hence, the fund manager needs to maintain a high cash reserve to cater to redemption requests.
Who should invest in open ended funds?
Open ended funds are the most significant part of the mutual fund market in India. Hence, most of the investors invest in a mutual fund that is open ended. Investment in open ended mutual funds depends on the investment objective of the investor. These funds are suitable for investors who want easy access to liquidity. Individuals can diversify their investment portfolios based on their understanding of risk.
In addition to the above, investors should also meet the eligibility criteria laid by SEBI. As per SEBI, investor of a mutual fund can be –
- Indian residents above 18 years of age
- Non-Resident Indians (NRIs)
- Person of Indian Origin (PIO) residing abroad
- Companies (including public sector companies)
- Corporate bodies
- Trusts and cooperative societies
- Religious and charitable trusts
- Private trusts
- Foreign institutional investors (FIIs) registered with SEBI.
- Other individuals or institutions approved by Asset Management Companies (AMCs)
Individual investors have to pay tax on the capital gains from mutual funds. In the case of open ended mutual funds, the taxation varies with the percentage of investment in debt and equity.
- If the fund invests 65% of its total assets or more in debt instruments, the tax treatment is as per debt fund.
- If the fund invests 65% of its total assets or more in equity instruments, the tax treatment is as per equity fund.
Therefore, the investors should read the offer document carefully to understand asset allocation.
Investment in open ended mutual funds has a lot of benefits. They offer professional management, diversification, lost cost and a dedicated fund manager. Investors can also expect substantial returns and capital appreciation from mutual fund investments. One has to make a proper financial plan before creating a diversified portfolio of mutual fund investment.
Usually, all mutual funds carry some amount of risk. Thus, as an investor, it is essential to go through the policy document carefully before investing. Also, it helps in understanding the asset allocation and other factors offered by the fund house and where the money is invested.
Frequently Asked Questions
In an open-ended mutual fund, the NAV changes on a daily basis due to stock market movements and change in bond prices. An open-ended fund starts after the NFO ends. Investors can enter and exit the fund anytime they wish to. While in a close-ended fund, the mutual fund does not allow entry and exit after the NFO period until its maturity. Therefore, a mutual fund that allows investors to invest and exit any time and publishes its NAV daily is an open-ended mutual fund.