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Difference Between Open Ended and Close Ended Mutual Funds
Open-Ended and Close-Ended Mutual Funds- A Comparative Analysis
here are several types of mutual funds in India. Among the various categorizations of these funds to enable informed decision-making by investors, mutual funds are termed open-ended, close-ended, or interval funds. Let us delve deep into the difference between open-ended and closed-ended mutual funds.
Open Ended Mutual Funds
An open-ended mutual fund is flexible in terms of the period of subscription and maturity. In other words, the units of an open-ended scheme can be purchased at any time during the year and redeemed by the investor at their convenience. This translates into a variable corpus, unlimited issue of units, and high liquidity.
An open-ended mutual fund has the following benefits-
- The scheme offers flexibility in terms of investment and redemption.
- These are highly liquid; therefore, investors enter and exit the market conveniently.
- It allows for a risk spread through portfolio diversification
- It is an affordable investment avenue since it is eligible for SIP, which allows for rupee cost averaging
- Investors can make informed investment decisions since past records regarding the fund are available.
Although open-ended mutual funds have a host of advantages, there are a couple of drawbacks. Some of them are listed below.
- Open-ended schemes are subject to greater risks because of the regular fluctuations in NAV.
- The decision-making power concerning asset composition rests with the fund manager mainly. Therefore, investors depend on them when choosing the securities that make up the fund.
- An exit load is applicable at the time of redemption, which affects the net gains.
Close-Ended Mutual Fund
A close-ended fund is limited and is available for subscription during the New Fund Offer (NFO) period. After which, the units are listed on a recognized stock exchange where they are traded like stocks, subject to market fluctuations. The units in a close-ended scheme can be redeemed post the maturity period. Therefore, they have a fixed corpus, limited issues, and low liquidity.
Let us look into the advantages offered by an open-ended mutual fund.
- A close-ended scheme has reasonable stability because the asset base and valuation are not subject to rapid change.
- Such a fund is not vulnerable to large inflows and outflows
- Investors benefit from compounding benefits by remaining invested for the long term.
- The fund manager can exercise their expertise and make sound investment decisions since they do not feel the redemption pressure.
- There is scope for liquidating one's holdings as the shares are traded on the stock exchange.
Given the advantages of a close-ended scheme, it also suffers from the following limitations.
- There is no ease of entry since subscription close after the NFO period is over.
- A lump sum amount is invested for an extended period. There the capital is locked in, which would otherwise have been used to explore other investment opportunities.
- This investment mode is unsuitable for salaried individuals and people with limited funds because it demands lump sum payments and does not allow for investment through SIP.
- There is no access to past performance records of the fund, which makes sound analysis difficult.
Difference Between Open-Ended and Close-Ended Mutual Funds
Let us identify the key differences between an open-ended mutual fund and a close-ended mutual fund based on the following parameters-
By definition, an open-ended mutual fund offers units to investors continuously. And there is no limit on the issue of these units. Hence, the term 'open.'
The units of a close-ended mutual fund are only available for a limited period. These are issued through the New Funds Offer (NFO). Post the NFO period; the fund units are traded on stock exchanges, similar to stocks.
In the case of open-ended mutual funds, the subscription period is indefinite, wherein fund units are issued throughout the year.
While close-ended mutual funds can be subscribed to only during a fixed period during the NFO.
The period of maturity is not predetermined in an open-ended mutual fund scheme. It is subject to variations.
In a close-ended scheme, the fixed maturity period usually ranges from three to five years.
Open-ended mutual funds are highly liquid, meaning one can redeem units in an open-ended mutual fund scheme subject to individual discretion and convenience. An open-ended mutual fund is, by nature, liquid.
Speaking of close-ended mutual funds, they are not illiquid, but this liquidity is on account of the stock market listing and not by default.
The corpus is variable in an open-ended mutual fund because there is no restriction on the number of units of the fund that can be issued.
In a close-ended scheme, the corpus is fixed since a fixed number of fund units are traded in the stock exchange.
The units of an open-ended mutual fund are not listed on a stock exchange because they are not subject to trading in the open market.
Conversely, the units of a close-ended mutual fund are listed on a recognized stock exchange, where they are bought and sold depending on the forces of demand and supply.
Execution of Transactions
Open-ended mutual fund transactions are executed at the end of each day. Due to this, the NAV fluctuates daily and poses a high risk to investors.
Trades of a close-ended mutual fund are executed in real-time, as in the case of stocks.
The price of an open-ended scheme unit can be determined by dividing its NAV by the number of outstanding units.
The price for a close-ended mutual fund scheme is determined by the forces of demand and supply in the open market.
In the case of an open-ended mutual fund scheme, the selling price is the total of the NAV and the load, if any. A load is charged when purchasing units of a mutual fund or at the time of sales. When the load is paid at the time of purchase, it is known as a front-end load since it is paid upfront.
Conversely, payment of load at the time of sale is known as the back-end load. The load varies with variations in the class of mutual funds. Units under a close-ended scheme can be sold either at a premium (at a price above the NAV) or a discount (at a price below the NAV).
Open-Ended Mutual Fund or Close-Ended Mutual Fund- Which of the Two is Better?
To discern which of the two types of mutual funds is suitable for an investor, two things need to be considered- resource availability and the preferences of an individual investor.
If an investor has ample money to remain invested for the long term, expects a good return, and prefers less risk- close-ended funds are the way to go.
On the other hand, if the investor has a risk appetite and is looking for short-term gains by investing a small sum of money, they can take the other route.
A thorough analysis of the difference between open and closed-end mutual funds will help an investor arrive at a mutual fund investment option suited to their needs and preferences.
How can you say whether a mutual fund is open-ended or closed-ended?
Unless stated otherwise, a mutual fund is open-ended. The units of an open-ended fund are created when an investor buys them, and they cease to exist once they are sold. Closed-ended mutual funds are traded on a recognized stock exchange.
Are open-ended funds redeemable?
Yes, open-ended mutual funds are redeemable, allowing investors to enter and exit the fund at their convenience. These funds are available for subscription all year round at the NAV, which is its purchase price, and other fees and commissions.
What do you mean by a load in an open-ended mutual fund?
When units of a mutual fund are bought or sold, a sales commission is paid by the purchaser of the fund. This commission is the compensation paid for the intermediary's services, such as the broker, an investment advisor, or a financial planner. The compensation paid is known as the load, and a fund that entails a load is known as a load fund.
How is an interval fund similar to an open-ended and close-ended mutual fund?
Interval funds are a mix of open-ended and closed-ended mutual funds. Such a fund invests in equity instruments, debt instruments, or a blend of both. The units of an interval fund can be bought and sold during stipulated time intervals at the prevailing NAV and can be redeemed after the period of maturity.
The fund house determines the permitted intervals during which funds can be redeemed. The fund manager gets enough space to devise an investment strategy without worrying about liquidation and redemption requests by the investors.