Open Ended Vs Close Ended Mutual Fund Schemes
Mutual funds differ from each other primarily based on their investment structure. This fundamental aspect governs the flexibility and ease of buying and selling mutual fund units.
When the mutual fund house offers a new mutual fund scheme, the scheme is introduced to investors through a New Fund Offer (NFO). During this period, you can invest in mutual fund schemes. However, once the NFO period is over, the scheme might or might not allow further purchases by existing or new investors.
It is where mutual funds become structurally different from open-ended and close-ended ones. This blog explores the critical differences between open-ended and close-ended mutual fund schemes.
What is an Open Ended Mutual Fund?
Open-ended funds are what one knows as mutual funds. These funds do not trade publicly. However, they have no limit on the number of units they can issue. The NAV changes daily due to movements in the fund's share/stock market and bond prices.
Open-ended mutual fund units are traded on demand at their Net Asset Value, or NAV, which is determined by the fund's underlying securities and calculated at the end of each trading day. Units are bought directly from a fund by investors.
Open ended fund investments are valued at fair market value and the closing market value of listed public securities. These funds are likewise not restricted.
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.
Pros and Cons of Open Ended Mutual Funds
Some of the pros and cons of open-ended mutual funds are:
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Open Ended Funds - Pros & Cons |
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Pros |
Cons |
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High liquidity—investors can redeem units at any time. |
May lead to lower returns due to frequent withdrawals by investors. |
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Flexibility in investing as there is no fixed tenure. |
May require active management, which can increase fund management costs. |
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Units are bought and sold based on the Net Asset Value (NAV). |
NAV can be volatile due to market fluctuations, affecting returns. |
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Continuous entry and exit options offer better control. |
Large-scale redemptions can impact fund performance. |
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Ideal for investors seeking liquidity and easy access to funds. |
Less suited for long-term goals if frequent withdrawals occur. |
What are Closed Ended Mutual Funds?
Closed ended mutual funds have a predetermined amount of fund units exchanged on stock exchanges. Close-ended funds operate more like exchange-traded funds (ETFs) than mutual funds. They are issued through a new fund offer (NFO) to raise funds and traded on the open market, analogous to stocks.
While the fund's worth is based on the NAV, the fund's actual price is proportionate to supply and demand. Thus, it could trade at higher or lower prices than its true value.
As a result, closed-end funds can trade at premiums or discounts to their net asset values (NAVs). Brokers are used to buying and selling closed-ended fund units. Closed mutual funds trade at a premium to their underlying asset value and have a predetermined maturity period.
Investors who seek to exit the scheme may sell the units in the open market. However, given the limited liquidity and the closed-ended nature, finding a seller for your desired price may also take time and effort.
Some close-ended funds offer an option of buying back the units after a specific time. It also allows investors an exit route before the maturity date.
Pros and Cons of Closed Ended Mutual Funds
The advantages and limitations of closed ended mutual funds are:
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Closed Ended Mutual Funds - Pros & Cons |
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Pros |
Cons |
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Fixed investment period encourages discipline and long-term growth. |
Limited liquidity; can only be redeemed upon maturity. |
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Managers can focus on long-term strategies without worrying about frequent redemptions. |
Lower flexibility, as investors can only enter during the initial offer period. |
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Units often trade at a discount or premium on exchanges, potentially creating additional value. |
Market prices can fluctuate more than NAV, impacting resale value. |
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Typically more suited for investors with long-term objectives. |
Performance may be impacted by economic cycles during the lock-in period. |
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Predictability due to a fixed number of units and closed-ended nature. |
Investors may face exit load fees if they sell on the secondary market. |
Difference Between Open-ended and Closed-ended Mutual Fund Schemes
Here are the critical differences between Open-ended and Close-ended Mutual Fund Schemes-
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Comparison Basis |
Open-ended Funds |
Closed-ended Funds |
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Definition |
Open-ended funds are schemes that continuously offer different units to investors. |
Closed-ended funds are mutual funds that provide new units to investors for a limited time. |
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Subscription |
These funds are available for subscription all year |
Some funds are only accessible for subscription on assigned days |
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Investment |
You can invest through SIPs or lump sum. |
You can invest only in a lump sum. SIPs are not available. |
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Transactions |
Executed at day end |
Real-time execution |
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Maturity |
No fixed maturity |
Fixed maturity period, usually 3 to 5 years |
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Liquidity provider |
Funds itself |
Stock Market |
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Corpus |
Variable |
Fixed |
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Price Determination |
The price is calculated by dividing the NAV by the total outstanding shares. |
Supply and demand drive price. |
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Listing |
There is no stock exchange listing; transactions are handled directly through the funds listed |
Listed for trading on a regulated stock market. |
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Issue Size |
Unlimited |
Fixed |
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AUM |
The AUM of the fund constantly changes |
Fixed AUM |
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Tax Benefits |
On ELSS investments |
No tax benefits on investments |
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Fund Control |
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 the asset base is stable. |
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Analysis |
You can compare and analyse similar schemes based on their records |
No record is available, so comparison or analysis is not possible |
Which One Should You Choose?
The choice entirely depends on your investment needs and preferences.
If you can afford to stay invested for a more extended period, you can opt for close-ended funds that give you stability and chances of higher returns through the 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.
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