All’s well that ends well?
Yes, can say that for mutual funds, if the mutual fund category is meeting your investment needs.
While the overarching concept remains consistent, the operational mechanics of mutual funds vary significantly, primarily categorised into open-ended and close-ended structures.
Let us learn “What are Open Ended Mutual Funds?” and the crucial difference between open ended and closed ended mutual funds.
What are Open Ended Mutual Funds?
Open ended mutual funds are the most common type of mutual fund available to investors, characterised by their continuous nature. Unlike their close-ended counterparts, open-ended funds do not have a fixed number of shares or a predetermined maturity date. They are continuously open for subscriptions (buying units) and redemptions (selling units) directly with the fund house. This constant flow of money means the fund’s capital base and the number of outstanding units fluctuate daily.
Here are the defining features of an open-ended mutual fund:
1. Continuous Subscription and Redemption
Investors can buy new units from the fund house or sell their existing units back to the fund house at any point during market hours. This offers unparalleled flexibility.
2. NAV-Based Pricing
When you invest in or redeem an open-ended mutual fund, the transaction occurs at the fund’s Net Asset Value (NAV). The NAV is calculated at the end of each trading day and represents the per-unit market value of the fund’s underlying assets. This ensures fairness, as you always transact at the true intrinsic value of the fund.
3. No Fixed Maturity
Open-ended funds do not come with a predetermined maturity date. They essentially “exist forever,” as long as there are investors and the fund house maintains the scheme. This allows for long-term investment horizons.
4. High Liquidity
Due to the direct redemption option with the fund house, open-ended mutual funds offer high liquidity. Investors can convert their investments into cash relatively quickly, usually within a few business days.
5. Flexible Investment Options
Open-ended funds allow for various investment methods, including lump-sum investments and Systematic Investment Plans (SIPs). SIPs enable investors to regularly contribute smaller, fixed amounts, fostering disciplined saving and rupee-cost averaging.
6. Track Record Availability
Since open-ended funds operate continuously, investors have access to extensive historical performance data. This track record helps in evaluating the fund’s consistency and manager’s expertise before investing.
Understanding Close Ended Mutual Funds
Here are some key aspects of close ended mutual funds:
1. Fixed Number of Units and NFO
A close ended mutual fund launches with a fixed number of units during an initial New Fund Offer (NFO), similar to a stock IPO. Investors can only subscribe during this limited NFO period, which typically lasts around 15 days. Once the NFO closes, no new units are created by the fund house.
2. Maturity Date
A distinctive feature of a close ended mutual fund is its maturity date. Your money remains locked in until this date, which commonly ranges from 3 to 5 years or even longer. At maturity, the fund’s assets are liquidated, and proceeds are distributed to unit holders.
3. Exchange-Traded
While you cannot redeem units directly with the fund house after the NFO, SEBI (Securities & Exchange Board of India) mandates that units of a close ended mutual fund must be listed on a stock exchange. This allows investors to buy or sell their units in the secondary market, just like regular stocks, before maturity.
4. Market Price Fluctuations
Unlike open-ended funds, the market price of a close ended mutual fund on the stock exchange can trade at a premium (above its NAV) or, more frequently, at a discount (below its NAV). This deviation from NAV is driven by market supply and demand, liquidity, and investor sentiment.
5. Lump-Sum Investment
Generally, only lump-sum investments are accepted in a close ended mutual fund during its NFO period. SIPs are not an option for these funds.
6. No Historical Performance Track Record at Inception
Since a close ended mutual fund is a new offering during its NFO, it does not have a past performance record for investors to review before investing. Investors rely on the Scheme Information Document (SID) and the fund’s objectives.
Difference Between Open Ended and Closed Ended Mutual Funds
Check the table below for the difference between open and closed ended mutual funds:
| Feature | Open Ended Mutual Fund | Close Ended Mutual Fund |
|---|---|---|
| Availability for Investment | Continuously available for purchase and sale. | Available only during a limited New Fund Offer (NFO) period. |
| Capitalisation | Variable; the number of units outstanding fluctuates. | Fixed; a predetermined number of units are issued. |
| Trading Method | Directly with the mutual fund house. | Traded on a stock exchange like regular shares. |
| Pricing Mechanism | Always at Net Asset Value (NAV). | Market price can be at a premium or discount to NAV. |
| Liquidity | High; units can be redeemed with the fund house anytime. | Lower; depends on finding a buyer on the stock exchange. |
| Maturity Date | No fixed maturity date; continues indefinitely. | Has a pre-defined maturity date (e.g., 3-5 years). |
| Investment Options | Allows both lump-sum and Systematic Investment Plans (SIPs). | Primarily accepts lump-sum investments during NFO. |
| Historical Performance | Extensive historical data available for analysis. | No historical track record at the time of NFO. |
Deciding Between Open and Close Ended Mutual Funds
The choice between open and close ended mutual funds depends on your investment philosophy, liquidity needs, and comfort level with market-driven pricing.
1. Opt for an Open Ended Mutual Fund if
You prioritise high liquidity, prefer the simplicity of NAV-based pricing, desire the flexibility of SIPs, and wish to redeem your investment directly with the fund house at any time. These funds are generally suitable for most retail investors seeking convenience and flexibility.
2. Consider a Close Ended Mutual Fund if
You have a long-term investment horizon and do not anticipate needing your funds before the maturity date. You are comfortable with the concept of investing a lump sum during an NFO and understand that the fund’s market price might trade at a discount or premium to its NAV on the exchange. Some investors may find these funds appealing for specific strategic allocations or to capitalise on potential discounts.
Made your decision yet? Scout for top funds using this link.
Wrapping Up
The clear difference between open ended and closed ended mutual funds is crucial for every investor to grasp. Open-ended funds can offer unparalleled flexibility and liquidity, making them a cornerstone of many investment portfolios. You need to understand the distinct operational models and implications of different mutual fund categories. Thus, you can align your investment choices with your financial goals and navigate the mutual fund landscape with greater confidence.
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