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Mutual funds vary primarily due to differences in their investment structures. This necessitates the flexibility and convenience of buying and selling mutual fund units.
There are times when a mutual fund house introduces a new scheme to investors. It typically does so through a New Fund Offer period. During this window, investors can participate in the mutual fund scheme by making investments. However, the new fund offer period may come to an end. Then, the scheme may or may not permit further investments from existing and new investors.
This is where the structural distinction between open ended vs close ended mutual funds becomes apparent. Here you can find the crucial difference between open ended and close ended mutual fund.
Open-ended mutual fund
Open-ended funds are commonly recognized as mutual funds that operate without trading on the open market. They do not impose any limit on the number of units they can issue. The Net Asset Value of these funds fluctuates regularly. It is due to changes in share and stock market prices and bond values within the fund.
Units of open ended mutual funds are bought and sold at their Net Asset Value on demand. It is determined by the value of the fund’s underlying securities and computed at the close of each trading day. Investors directly purchase units from the fund.
Investments in open-ended funds are assessed at fair market value, reflecting the closing market value of publicly listed securities. Moreover, these funds do not feature a fixed maturity period.
Benefits of open ended mutual funds
Open ended mutual funds allow investors to buy and sell units directly from the fund. They do not have to trade on the stock market. This offers flexibility and liquidity to enter or exit the fund anytime at the prevailing Net Asset Value without restrictions. The number of units does not limit open-ended funds, hence fund sizes can grow organically with new inflows. This leads to economies of scale which may reduce expenditure ratios.
Investors can start with small amounts and increase investments over time. Portfolio managers have the flexibility to manage cash flows efficiently. Open-ended structure makes these funds a favoured route for Systematic Investment Plans. Familiarity, flexibility, low investment amounts and the ability to create recurring investments make open-ended mutual funds popular among retail investors.
Closed-ended mutual funds
Closed-ended mutual funds allocate a fixed number of fund units that are traded on stock exchanges. They function more akin to an exchange-traded fund rather than a traditional mutual fund. These funds are introduced through a new fund offer to raise capital and subsequently traded on the open market. It resembles the trading dynamics of stocks.
While the fund’s value is rooted in the Net Asset Value, its actual price is determined by supply and demand. This results in potential trading at prices either above or below its intrinsic value. Consequently, closed-ended funds may trade at premiums or discounts to their NAVs. Units of closed-ended funds are bought and sold through brokers, and these funds typically trade at discounts to their underlying asset value. Additionally, closed mutual funds feature a fixed maturity period.
Benefits of close ended mutual funds
Between open ended and closed ended mutual funds, the latter raises a fixed amount of capital via NFOs and have a specified maturity period. Units are listed on stock exchanges so investors can buy/sell during the tenure. This predetermined capital base allows fund managers to invest with a longer-term horizon without worrying about redemptions. Lack of inflows/outflows lends stability to portfolio strategy.
Close-ended funds can take higher exposure to illiquid assets as they need not maintain liquidity to service redemptions. These funds are more tax-efficient as portfolio churn is lower. Units can be bought or sold anytime on the exchange, so investors can also profit from market price movements. Close-ended structure suits investing for specific events like retirement, children’s education etc. Overall, they offer portfolio stability, tax efficiency and the ability to profit from market pricing for investors with defined time horizons.
Comparative analysis of open ended and close ended mutual funds
The difference between open ended and close ended mutual fund are as follows.
| Aspect | Open-Ended Mutual Funds | Close-Ended Mutual Funds |
| Fund Structure | Investors can buy and sell units at any time | Investors can buy units only during the initial offer period and sell them on the stock exchange |
| Duration | Perpetual – No fixed maturity date | Fixed maturity period set at the time of launch |
| Fund Size | Flexibility to expand or shrink the fund size based on investor demand | Fund size remains fixed throughout the tenure |
| Pricing | NAV (Net Asset Value) calculated daily | NAV calculated periodically (weekly/monthly) |
| Liquidity | High liquidity due to continuous buying and selling of units | Liquidity depends on demand in the secondary market |
| Redemption | Redeemable at any time with no restrictions | Redeemable only at the end of the maturity period |
| Pricing Premium/Discount | NAV usually remains close to the actual value of the underlying assets | NAV may trade at a premium or discount to the underlying assets depending on market demand |
Which one should you choose?
The decision of choosing between open and close ended mutual funds ultimately hinges on your investment requirements and inclinations. You may have the capacity to commit to a longer investment horizon. Then you can consider close-ended funds. It offers stability and the potential for enhanced returns through compounding your investments over time.
Investing in close-ended funds typically necessitates available lump sum amounts. Moreover, liquidity could be a priority for you. Then open-ended funds may represent a more suitable option.
Conclusion
One major drawback of closed-ended funds is their lack of flexibility regarding investor withdrawals. This is because investors cannot withdraw their invested amount at their discretion. In contrast, open-ended funds provide investors with flexibility in this regard. It allows them to withdraw funds continuously under a repurchase agreement.
It’s essential to consider the difference between open ended and close ended mutual fund carefully before determining the appropriate investment option for you. Regardless of the type of mutual fund you intend to invest in, opening a demat account is essential. Several reputable platforms offer demat and trading accounts for free. Simply visit their platform’s website to apply for one and embark on your wealth creation journey.
FAQs
The Net Asset Value represents the market value of the securities within a mutual fund scheme. It is calculated by dividing the market value of the securities by the total number of units of the scheme on a particular day. The market value of securities fluctuates daily, so the Net Asset Value varies accordingly.
Closed-ended funds allocate investments across both foreign and domestic securities. These encompass a range of asset classes such as common and preferred stocks and municipal and corporate bonds. It includes the high yield bonds.
Unless specified otherwise, a mutual fund is typically open-ended. In an open-ended fund, units are generated when investors purchase them. They are eliminated when they are sold. On the other hand, closed-ended mutual funds are traded on recognized stock exchanges.
Indeed, open-ended mutual funds are redeemable, enabling investors to enter and exit the fund at their convenience. These funds are accessible for subscription throughout the year at the Net Asset Value. It represents its purchase price, along with other associated fees and commissions.
When investors buy or sell units of a mutual fund, they pay a sales commission to the intermediary facilitating the transaction, such as a broker, investment advisor, or financial planner. This commission serves as compensation for the intermediary’s services. The payment made is referred to as the load, and a fund that imposes a load is termed a load fund.
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