Open Ended & Close Ended Mutual Funds Explained
Mutual funds are classified according to their structure, such as whether they are open-ended or closed-ended. The differences between these two types of funds come down to flexibility and the simplicity with which fund units can be sold and purchased.
Open Ended Mutual Funds
Open-Ended funds do not trade on a public exchange. They have no limit on the number of units they can distribute. Because of the fund’s share/stock market volatility and bond prices, the NAV changes every day.
Open-ended mutual fund units are purchased and sold on demand at their Net Asset Value, or NAV, which is computed at the end of each trading day and is based on the value of the fund’s underlying securities. Investors purchase units directly from a fund.
The investments in open-ended funds are valued at their fair market value, which is also the closing market value of listed public securities. These funds don’t have a set maturity date, either.
Advantages of open-ended funds
Liquidity: Open-ended funds have a lot of liquidity, which means you can redeem your units whenever you want. Unlike other types of long-term investments, open-ended funds allow for redemption at the current Net Asset Value (NAV).
Availability of Track Record: Due to the lack of a track record in the case of a closed-ended fund, you are unable to compare the fund’s performance across market cycles. BUT In the case of open-ended funds, the fund’s historical performance is available. As a result, investing in an open-ended fund is a wise decision.
Systematic Investment Form: Closed-ended funds require investors to make a lump-sum investment to purchase the fund’s units at the time of its commencement. This can be a risky way to handle your investments. Open-ended funds, on the other hand, are a good investment option for a lot of salaried investors. It’s because they have the ability to invest through systematic investment plans (SIP).
Disadvantages of Open-Ended Funds
Market Risk: Open-ended funds are vulnerable to market risk, despite the fact that the fund manager maintains a well-diversified portfolio. The fund’s NAV varies in response to the changes in the underlying benchmark.
Open-ended funds hire fund managers that are well-qualified and have previous expertise in the market. They make all of the decisions about the fund’s securities selection. As a result, the investors have no input in the asset composition of the fund. Also read: How To Choose The Right Fund Manager – Basic Criteria
Closed-ended mutual funds
Closed-Ended Funds have a predetermined amount of fund units that are exchanged on stock exchanges. Closed-ended funds are more similar to exchange-traded funds (ETFs) than mutual funds. They are raised through a new fund offering (NFO) and then traded on the open market, much like stocks.
Though the fund’s value is determined by the NAV, the fund’s actual price is determined by supply and demand, thus it can trade at prices above or below its true value.
As a result, closed-end funds can trade at a premium or a discount to their net asset values (NAVs). Brokers are used to buying and selling closed-ended fund units. Closed mutual funds trade at a discount to the value of their underlying assets. These funds have a set maturity date as well.
Benefits of Closed-End Funds
Closed-ended funds have a stable asset base since investors can only redeem their units on predetermined dates, such as when the fund matures. This provides a stable asset base to the portfolio manager that is not subject to frequent redemptions.
Stable Asset Base: A stable asset base makes it easier for the fund manager to create an investing plan. In the case of stable asset bases, fund managers can also keep the fund’s overall objectives in mind without having to worry about inflows and outflows.
Market Prices: Closed-ended funds, like equity shares, are typically traded on stock exchanges. This allows investors to buy and sell fund units based on real-time values that may be higher (premium) or lower (discount) than the fund’s NAV. They can also use standard stock trading tactics such as market and limit orders, as well as margin trading.
Liquidity and Flexibility: Investors can liquidate closed-ended funds according to the fund’s rules. Investors can buy and sell closed-ended fund units at market prices using real-time pricing accessible during the trading day. This gives them the required freedom to make investment decisions based on real-time data.
Disadvantages of Closed-end funds.
Poor Performance: Over a variety of time horizons, closed-ended schemes have not performed as well as open-ended funds. The lock-in period on closed-ended funds, which is supposed to give fund managers more flexibility in allocating funds without fear of outflows, hasn’t helped much in terms of improving returns.
Lump-sum Investment: Closed-ended funds require you to make a lump-sum investment at the time of their inception. This can be a risky way to handle your investments. It allows you to place larger wagers than would otherwise be possible. Furthermore, a considerable proportion of paid investors are unable to make lump-sum investments. Instead, they prefer systematic investment strategies with periodic investments (SIP).
Non-availability of track record: Because historical data is available for open-ended funds, investors can examine their performance over multiple market cycles. but The track record of closed-ended funds is not available. As a result, investment in a closed-ended fund has risks that you can only rely on the fund manager to mitigate.
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