Open-ended and closed mutual funds are just different categories of mutual funds. At the outset, these terms might look complicated or technical. However, these are very basic and easy to understand.
Specifically, in the context of your investing in mutual funds.
In this article, we will take up the topic of open and closed-ended mutual funds. What do they mean, what are the differences and how they are relevant to you?
In this article
- What Is an Open-Ended Mutual Fund?
- What is a Closed-Ended Mutual Fund?
- Advantages of Open-Ended Funds
- Disadvantages of Open-Ended Funds
- Advantages of Close-Ended Funds
- Disadvantages of Closed-Ended Funds
- Open-Ended Vs Closed-Ended Mutual Funds: Inference
What Is an Open-Ended Mutual Fund?
Open-ended funds are those category of mutual funds which you know of in common usage.
Open-ended mutual fund units can be bought and sold on demand, on a daily basis, at their Net Asset Value or NAV. Their NAV is dependent on the value of the fund’s underlying securities.
These funds do not trade in the open market. Investors can buy the units of an open-ended mutual fund directly from the fund itself. Unlike other funds, open-ended mutual funds do not have a fixed maturity period.
These schemes purchase and offer units on a daily basis and henceforth, enable investors to enter and exit according to their benefit.
What is a Closed-Ended Mutual Fund?
Unlike open-ended mutual funds, closed-ended funds issue a fixed number of units that are traded on the stock exchange.
They sell only a specific number of units and their NAV does not change on a daily basis. Also, investors do not have the option of buying the units of a closed-ended fund after its NFO period is over.
A closed-ended mutual fund resembles an exchange-traded fund more than a mutual fund.
New investors cannot enter, nor can existing investors exit till the term of the closed-ended scheme ends. However, to ensure liquidity – buying/selling, the closed-ended schemes are listed on a stock exchange. SEBI regulations ensure that closed-ended funds provide at least one of the two avenues to investors for entering or exiting.
Advantages of Open-Ended Funds
Convenience in Entry and Exit
Open-ended funds offer high liquidity to the unit holders of those funds. The reason is that you have the freedom to redeem or sell the units of the fund as per your convenience.
This is in contrast to the other types of funds and investments, which can be highly il-liquid. Investors can buy and sell the units of these funds on a daily basis – thus, avoiding blockage of funds.
It also facilitates easy transfer of investment from one fund to another.
Tracking Historical Performance
Keeping track of your investments and their performance is extremely essential. Open-ended funds can be tracked for their historical performance. This enables periodic review and decision making.
If the performance of the funds is in line with the expectation, no buy/sell is required. However, if the performance of the fund is not in line with the expectation, then it could prompt the need for buying/selling.
However, this facility is not available In the case of a closed-ended fund. You will not be able to track the performance of your fund over different market cycles in a closed-ended fund.
Option to Invest via Systematic Investment Plan
A lot of investors want to invest in mutual funds, but do not have a large sum of money which is required for lumpsum purchase (as is the case with closed-ended funds).
Open-ended funds come to the rescue in this case. They allow investment in whatever quantity and amount required. This is possible through the Systematic Investment Plan option.
In an SIP, you can invest small sums of money (as low as ₹500) in periodic intervals (usually monthly).
Close-ended funds do not have this option and usually require a large amount of money up-front. This makes for a riskier investment, not suitable for everyone, especially a lot of retail investors.
Disadvantages of Open-Ended Funds
Market risk means that the NAV of the funds fluctuate on a day-to-day basis. This is based on the fluctuation in the price of the underlying securities.
This means that if the stocks in the portfolio fall drastically, the NAV of the fund will also fall drastically.
Market risk increases the risk of investment inspite of the fact that the fund manager of open-ended funds maintains a highly diversified portfolio.
No Say in Asset Composition
Open-ended funds are managed by professional fund managers, who take all the decisions, regarding selection of securities for the fund.
The investors do not have a say in the selection of the securities or asset composition of the fund.
Advantages of Close-Ended Funds
Stable Fund Size
A closed-ended fund has a stable fund size. The main advantage of a stable asset base is that the fund manager can comfortably formulate an investment strategy. He will be assured of the availability of funds on a regular basis.
Traded on Stock Exchanges
As the unit of closed-ended funds are traded on stock exchanges like equity shares, the investors can buy/sell units of the fund based on real-time prices.
This is similar to what the investors are used to when trading in stocks via the stock exchanges, therefore, it is more convenient and easily acceptable.
Disadvantages of Closed-Ended Funds
Open-Ended Funds Perform Better
Performance of the closed-ended schemes is not at par with open-ended funds.
Along with the other restrictions like only lump-sum investment and greater investment horizon, this may not be a suitable investment choice for many small investors.
SIP Option Not Available
As opposed to open-ended funds, the option to invest monthly in small installments is not available here.
Closed-ended funds require you to invest in lumpsum and not in SIP. Investors are required to buy units of the fund at the time of their launch (NFO).
This may be a risky approach and not ideal for small investors who do not have large funds and want less risks.
No Tracking of Historic Performance
As discussed above, the performance of an open-ended fund can be tracked. However, in the case of closed-ended funds, this feature is not available.
In this case, the investors can only rely upon the fund managers. This restricts pro-active decision making.
Open-Ended Vs Closed-Ended Mutual Funds: Inference
On a purely return-generated basis, the open-ended schemes have outperformed close-ended schemes. This is to the extent that the least performing fund in the open-ended has outperformed the best performing fund from the close-ended scheme.
Specially, with the option to invest in open-ended schemes via Systematic Investment Plan, it is a convenient and practical choice.
For closed-ended funds, availability of funds, regularly, can be a big advantage over open-ended funds.
|Liquidity||100%, can be redeemed anytime||Not 100%, some lock-in|
|Listing||Not listed on stock-exchange||Listed on stock exchange|
|Freedom to fund manager||Have to operate under fluctuating asset base||Fixed asset base – better freedom for executing plans|
|NAV||Mark to market – changes daily||Listed at the time of NFO|
All in all, a lot depends on your investment objective and the risk appetite of the individual investor. The availability of funds for lumpsum investment is also an important determinant.
Disclaimer: The views expressed in this post are that of the author and not those of Groww.