Mutual funds differ from each other primarily on the basis of their investment structure. This fundamental aspect governs the flexibility and ease of buying and selling mutual fund units. When a new mutual fund scheme is offered by the mutual fund house, the scheme is introduced to investors through a New Fund Offer (NFO). During this period, you can invest in the mutual fund schemes. Once the NFO period is over, the scheme might or might not allow further purchases by existing or new investors.
This is where mutual funds become structurally different as open-ended and close-ended mutual funds. In this blog, we explore the difference between open-ended and close-ended mutual fund schemes and their key advantages.
Difference between open-ended and close-ended mutual fund schemes
|Open-ended funds||Close-ended funds|
|Can be bought or redeemed whenever you want. Only ELSS schemes have a lock-in period of 3 years||Can be bought only during the NFO and redeemed after the lock-in period is over|
|Traded freely on the stock exchange||Units of some funds are traded on the stock exchange, mostly at a discounted NAV|
|The number of issued units is unlimited||The number of issued units remain fixed|
|You can invest through SIPs or through lump sum||You can invest only in a lump sum. SIPs are not available|
|Tax benefits on ELSS investments||No tax benefits on investment|
|You can compare and analyse similar schemes based on their past records||No past record is available and so, comparison or analysis is not possible|
|Redemption happens at NAV that changes daily depending on the value of the portfolio at the end of the day.||NAV is determined at the time of the NFO. Upon maturity, scheme itself is dissolved and capital returned at NAV on that date.|
|The fund manager’s control over the portfolio is limited because of the possibility of redemptions||The fund manager has complete control over portfolio management as asset base is stable|
|The AUM of the fund constantly changes||The AUM remains fixed|
Open-ended mutual fund schemes are those mutual funds that do not have restrictions on the number of units of the fund in circulation. This allows investors to buy and sell the open-ended mutual fund units directly from the mutual fund house itself, instead of waiting for sellers to provide the supply. The investor can buy and sell units at the Net Asset Value (NAV) of a specific day and can be subscribed to by the investors even after the NFO is over. You can invest in the scheme whenever you want to and also redeem at your discretion.
Investors seeking high liquidity may consider investing in open-ended mutual fund schemes that have neither restrictions on the number of units one may purchase or redeem, nor have a maturity period. However, an exit load may be applicable when you redeem the units of open-ended schemes.
Here is a look at the pros and cons of open-ended schemes –
Unlike open-ended mutual funds, close-ended schemes are those which are offered only during the NFO period. This is because only a fixed number of units of the mutual fund are issued. Since the total portfolio size is fixed, no fresh investments are possible once the NFO period closes.
As for redemptions, closed-ended mutual fund schemes have particular maturity periods that are pre-decided and part of the offer document. Investors are not allowed to exit the scheme before the scheme matures. At maturity, the mutual fund house dissolves the closed-ended scheme and returns capital to the investors at prevailing NAV as on that particular date.
Note that close-ended funds are, nonetheless, listed on the stock exchange. Investors who seek to exit the scheme may trade the units in the open market. However, given the limited liquidity because of the closed-ended nature, finding a seller for the price you seek may also be tough. Some close-ended funds offer an option of buying back the units after a certain period of time. This also allows investors an exit route before the maturity date.
Here are the merits and demerits of close-ended schemes –
The choice entirely depends on your investment needs and preference. If you can afford to stay invested for a longer period, you can opt for close-ended funds that give you stability and chances of higher returns through compounding of your money over time. You will also require free lumpsum amounts to invest in closed-ended funds. On the other hand, if you want liquidity, open-ended funds may be a better option.