A lot of you might not know this, but based on the constitution, there are three main categories of funds, which are:

  • Open ended
  • Closed-ended
  • Interval fund

While an investor may choose to invest in any category of fund, it is always better to analyze that particular category of fund they are investing in.

In this blog, we will clear the concept of open-ended and closed-ended funds, before we delve deeper into how to assess these funds while seeking to invest.

Open-ended funds

The main characteristics of these funds are as follows:

1.The shares or the units of the fund can be purchased anytime from the fund house.

2.There is no limit to the number of shares available, as the fund house continues to create new shares as and when needed, to meet the investor’s demand.

3. On the flip side, a portfolio may change considerably, should there be a situation that a significant number of shares are redeemed quickly and the manager needs to make a trade (sell) to meet the demands for cash created by redemption.

4. Funds are priced once every day at the close of business

5. All investors make a transaction on a particular day at the same price called the NAV (Net Asset Value). Investors in the fund share costs associated with the management of the fund.

Closed-ended funds

1. Closed-end funds operate more like exchange-traded funds. These funds are launched by way of an Initial Public Offering (IPO) also known as New Fund Offer (NFO).

2. By way of IPO/NFO, the fund house raises a fixed amount of money by issuing a fixed number of shares. The fund manager utilizes the NFO proceeds to invest in securities as per the objective of the fund.

3. These funds also get listed on a stock exchange so that the units of the fund can be traded in the secondary market.

4. The trading difference between open-ended and closed-ended fund is beneficial for a fund manager, particularly for the ones who are dealing in segments such as small-caps, emerging markets, high-yield bonds and other less liquid securities.

5.Closed-end funds also have an NAV (similar to ETF or any open-ended fund). However, the market price quoted in the exchanges may be higher or lower than the NAV.

6. This trading price is determined by demand-supply in the marketplace. ETFs generally trade closer to their NAVs.

7. On the cost side of the equation, each investor pays a commission to cover the cost of the personal trading activity (that is, buying and selling of a closed-ended fund’s shares in the open market).

Why would you choose a close-ended fund?

1.Fixed Income

Investors who seek to invest in fixed-income securities. Because, many of these funds are designed to provide a steady stream of income (dividend plans).

These typically give returns monthly or quarterly as against to semi-annual payments provided by individual bonds

2.No regular redemption

Closed-ended funds are free from the concern of regular and sudden redemption. Thus, the fund managers are not really worried about the size of the fund.

Having said that, open-ended funds have outperformed closed-ended funds comprehensively.

How to make the best of a close-ended mutual fund?

If you, as an investor, want to invest in close-ended mutual funds and make the best of the advantages, here are some tips:

1.Thorough analysis of the portfolio

There is no past history, as the fund is declared only during an IPO.

This means you have to completely rely on your analysis of the portfolio. Before making any decision, you need to ensure that the portfolio you have chosen has the right set of securities for a better return on investment.

2. Consider low liquidity of the fund

Close-ended mutual funds offer low liquidity. Because, unlike open-ended funds, you do not have the option to exit anytime you wish.

An investor can sell the fund before maturity only through the stock exchange. Thus, you have to ensure that you are prepared to invest for a longer duration

3. An SIP option is not available

If you do not have a large amount of money to invets in and SIP (Systematic Investment Plan) is your solution, then these funds are not for you.

Close-ended mutual funds do not provide the flexibility of investing by way of a systematic investment plan. Thus, an investor has to invest the full amount at the time of the NFO (New Fund Offer).

Some close-ended funds are

1.Reliance Capital Builder
2.Sundaram Value Fund
3.Tata SIP Fund Series 3

Some open-ended funds are

1.Large-cap funds
2.Small cap funds
3.Balanced Funds
4.Debt Funds
5.Equity Linked Savings Scheme (ELSS) funds

Happy Investing!

Disclaimer: The views expressed in this post are that of the author and not those of Groww