So, you are looking to grow your wealth and secure your future but your mind is in a fix about investing in a close-ended mutual fund or an open-ended mutual fund? Well, worry not. Here is a quick explainer on the difference between the open ended mutual funds and close ended mutual funds.
While mutual funds in India differ on the basis of their risk appetite and cater to different classes of investors, they are broadly categorised into two types: close ended and open ended. To understand the dynamic of open ended mutual funds vs close ended mutual funds, one has to look at them from the lens of investment flexibility.
Open ended schemes can be purchased or sold at any time, while close ended schemes can only be purchased when the fund is being launched and can be redeemed only when the lock-in period for the investment is over.
Let us look at them in greater detail:
Open ended schemes:
Under these schemes, asset management companies buy and offer units to new investors on a daily basis. This facilitates an easy entry and exit for investors. The mutual fund units can be bought and sold after the New Fund Offer (NFO) timeline ends. The units in these kinds of mutual funds are sold and purchased at the Net Asset Value (NAV).
Open ended funds do not have a lock-in period or maturity timeline. They are perpetually open and hence easily redeemable. They also do not have a cap on the maximum limit of Asset Under Management (AUM) that they can accept from the public at large. In these schemes, the NAV of the units is calculated on the basis of the value of the underlying security at the end of each trading day.
When an investor invests in an open ended scheme, he buys directly from the fund. Their investment is subsequently valued as per the fair market value method, which is done at the end of trading hours, essentially, reflecting the closing price of the underlying securities.
These are highly liquid funds and suited for the candidates who wish to earn an annualised return of 12-15%. Professional fund managers handle these funds and with the NAV being updated on a daily basis, investors here enjoy more benefits as compared to those in the close-ended funds.
Close ended schemes
These funds have a lock-in period and cannot be redeemed before their maturity. These funds trade on the stock exchanges. Close-ended fund units are raised via NFOs and then traded in open markets. While the value of the fund is based on NAV, the real price of the fund is dependent on the demand-supply dynamic prevailing in the market. Because of this, it is quite possible that close ended mutual funds might trade at a discount to their underlying asset price.
Open ended mutual funds vs close ended mutual funds:
- High fungibility:
Open ended funds can be redeemed by the investors at any point of time. They can be redeemed at the prevailing NAV of the units. Close ended mutual funds have a lock-in period and cannot be redeemed before their maturity period.
- Investors can track performance of fund
In close ended funds, it is not possible to track the performance of the mutual fund. However, in open ended schemes, one can keep an eye on the performance of the fund through different economic and business cycles and the investor if he so wishes can choose to redeem his investment in case he is getting a handsome return. Investing in an open ended scheme gives you a clearer picture of your investments.
- Facility of a systematic investment
Open-ended schemes are perfectly suited for salaried employees who wish to reap returns from the markets. Open ended schemes offer working professionals the option to invest in small amounts via Systematic Investment Plans (SIP). This isn’t possible for close ended funds which require an investor to invest a lump sum amount at the launch of a fund. This is comparatively a riskier investment better suited to veteran investors who know the nitty-gritty of the market as well as the fund and can weather volatilities in case the business cycle works against the investment philosophy of the close ended mutual fund scheme.
- Non-fluctuating asset base
In a close ended scheme, investors are not allowed to withdraw their investment till the end of the lock-in period. This gives the fund manager an assured asset base that is not prone to frequent redemptions. This helps the fund manager devise a comprehensive investment strategy and remain committed to the investment philosophy despite the volatility in the markets. Worries of frequent redemptions don’t worry the close ended fund manager unlike the fund managers of open ended mutual funds.
Market research shows that open ended schemes have delivered potentially a much better yield compared to close ended schemes. Fund managers can supervise the management of a close ended fund without fearing sudden outflows in a close ended fund. Despite this, their returns haven’t been able to beat the returns given by open ended funds.
The final word:
Between open ended mutual funds and close ended mutual funds, experts suggest that it is always better to opt for open ended schemes as they allow investors to invest any surplus that they have in their hands and also allow them to exit the markets if the fund gives them good returns and helps them meet their financial goals. Close ended funds on the other hand lock in investments and investors do not have a clear idea of how their funds are performing.