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Open Ended Funds vs Close Ended Funds – What’s the difference?

Open ended vs close ended

Introduction

Mutual fund investments are among the most popular and attractive investments available in the market. Investment in mutual funds helps the investors to get exposure in debt and equity funds. Mutual funds are categorized based on their character, which includes risk factor, nature of the investment, structure of the fund and many more. They can be categorized into three types based on their structure, i.e. open ended fund, close ended funds and interval funds. 

In this article, we will understand open ended vs close ended funds in detail. 

What are open ended mutual funds?

Usually, every mutual fund is launched through a New Fund Offer (NFO). After the NFO ends, the mutual fund is launched as an open ended fund. Open ended funds are most commonly known as mutual funds. These funds do not trade in an open market. There is no limit on the number of units that they can issue. By investing in an open ended mutual fund, it allows investors to enter and exit the fund anytime. These funds are highly liquid as there is no lock-in period

In an open ended mutual fund scheme, the NAV changes daily based on the stock market movement and changes in the bond prices. The mutual fund units can be bought and sold anytime at its Net Asset Value NAV. The NAV or Net Asset Value of the fund is determined on the performance of funds underlying securities. The NAV is calculated at the end of every trading day. The open ended fund investments are valued at a fair market value which is the closing market value of the listed public securities. 

Advantages

Liquidity

Investors can redeem the fund units anytime based on their requirement and convenience. In comparison to other investments, these funds can be redeemed anytime at current Net Asset Value NAV. This adds a necessary component of liquidity and flexibility to the investor’s portfolio.  

Availability of historical performance

The open ended fund 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 make a wise investment decision.

Availability of Systematic options

open ended mutual fund schemes offer investors to use different systematic plans for making investments and withdrawals. The investor can choose SIP, SWP and STP based on their requirement. Usually, Systematic Investment Plans (SIPs) are ideal for salaried class investors or people without an investible surplus in their hand. Also, investing through  Systematic Investment Plans (SIPs) helps in building a corpus from scratch.

One can also use Scripbox’s SIP calculator for calculating the SIP returns.  

Portfolio Diversification

Open ended funds help investors to build a diversified portfolio based on their financial plan and investment objective. Also, diversifying the portfolio reduces the chances of risk overall.

Limitations

Volatility

Open ended mutual funds still experience market risk even though a fund manager actively manages them. The Net asset value of the fund fluctuates daily according to the movement of 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. 

No Say for Investor

Every open ended fund has a fund manager assigned who actively manages the fund. They are well qualified and have expertise in the field of fund management. They solely take decisions regarding buying and selling of securities of the fund. Hence, investors have no say in the asset allocation of the fund. 

Exit load

Open ended funds have exit loads. There are some 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. 

Cash Reserve

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. 

What are close ended mutual funds?

Close ended funds issue a fixed number of units that are traded on stock exchanges. The close ended funds are launched through a New Fund Offer (NFO). These funds function like exchange-traded funds(ETFs). Investors can purchase these funds during the NFO period. However, they do not have an option to buy units after the NFO closes. Also, the existing investors cannot exit from the fund until the maturity period. Thus, to ensure liquidity, the fund house lists the close ended scheme on a stock exchange where the investors can buy or sell units. In simple words, close ended mutual funds have a specific tenure and a fixed maturity date. 

The actual price of the fund is influenced by demand and supply as it can trade at prices above or below its real value. Therefore, these funds can trade at premium or discount to their NAVs. Usually, units of close ended funds are bought and sold through brokers. These funds typically trade at discounts to their underlying asset value. 

The number of outstanding units of this fund does not change as they are traded on stock exchanges. Apart from listing on a stock exchange, these funds offer to buy back units. Thus, this provides another avenue for liquidity to investors. SEBI regulations ensure that these funds provide at least one or two avenues to investors for entering and exiting. 

Advantages

Stability

In a close ended mutual fund, investors cannot redeem their money before the lock-in period. This gives the fund managers a stable asset base to work. It also helps the fund manager to devise strategy without worrying about the inflows and outflows from the fund. They need not fear to maintain liquidity since there are no redemptions. 

Market Price

The units of close ended schemes can be bought and sold on a stock exchange. The actual price of the fund is determined by the demand and supply of the units of the scheme. This allows investors to buy or sell units at real-time prices. They can be traded at premium or discount of the fund’s NAV Net Asset Value. 

Liquidity

The close ended schemes seem to be illiquid since the fund house does not allow redemption of units until the maturity. However, the stock exchange allows investors to buy and sell units at real-time prices. Hence, close ended schemes offer a high degree of liquidity to its investors. 

Limitations

Lumpsum Investment

One can invest in close ended funds only during the NFO period. Hence, investors can only make a lump sum investment in these funds. Also, this increases the risk for investors. Moreover, a large number of salaried class people cannot afford a lump sum investment. They prefer staggered investments through Systematic Investment Plans(SIPs)

One can also use Scripbox’s different return calculators that are available online for calculating their returns.

Non-availability of historical performance

The open ended fund offers a quick glimpse of the past performance of the fund across different market cycles. However, in close ended funds, the track record is unavailable. Hence, investing in close ended funds attracts uncertainties. Investors have to solely depend on the decisions of the fund manager for the fund performance. 

Open ended vs close ended mutual funds

The following are the parameters for open ended vs close ended funds – 

ParameterOpen Ended FundsClose Ended Funds
NAVThe NAV of the fund changes dailyThe NAV is listed at the time of NFO
Listing on Stock ExchangeNo Yes
Entry and ExitOne can invest and redeem anytimeOne can invest only at the time of NFO and redeem after the fund matures
Maturity periodThey do not have a fixed maturity periodThey have a fixed maturity period
LiquidityInvestors can redeem from this fund anytimeThey are partly liquid due to listing on the stock exchange
Asset BaseThe asset base keeps changing due to the entry and exit of the investorsThe asset base is fixed as the investor cannot enter the fund after the NFO period
Fund managementThe fund manager is under the pressure of operating due to the fluctuating asset base The fund manager doesn’t have to worry about the withdrawals as the asset base is stable
SIPInvestors can invest through SIP or choose any other systematic planInvestors can only invest through lump sum at the time of NFO
Fund sizeFlexibleFixed
TransactionsThe transactions performed at the end of the dayThe transactions happen on a real-time basis
RiskThese funds are less risky when compared to close ended fundsThese funds are riskier than open ended funds
Track RecordInvestors can have a glimpse of the fund’s past performance. This helps them to make a well-informed investment decisionThe past performance of the fund is not available. Investors have to depend on the fund manager for fund performance.

Conclusion

It may be challenging to choose between open ended vs close ended funds for investment purposes. However, one can decide their investment based on the performance of the fund. The fund performance is driven by the fund category, fund manager and their investment philosophy.  Investors should also keep in mind their financial plan and investment objective before investing. 

There are a variety of options which investors can choose from the mutual fund market. The major types of funds are equity mutual funds, debt funds and hybrid funds. Some of the equity mutual funds categories are large cap fund, mid cap fund, index fund and many more. For tax saving purposes, investors can also choose ELSS funds. Thus, every individual can choose to invest from these baskets of funds based on their investment purpose. 

Published on October 29, 2020