Mutual funds are an investment tool in which your money is pooled in a fund with the money of other like-minded investors. Once enough money is collected in the fund, it is used to purchase financial securities. The target for mutual funds investment includes assets such as money market instruments, gold, and stocks. By purchasing a unit in a mutual fund scheme, you get a chance to own a small stake in all the investments that are considered a part of the fund.
In India, mutual funds can be classifiedinto two types, in the terms of investment structure.The two types arean open-ended mutual fund and closed-ended mutual fund. Open-endedandclose-ended funds can be differentiated based on things like the function of investment schemes and the ease with which they can be bought or sold. While open-ended funds can be sold or purchased anytime, closed-ended funds are the opposite.
Close-ended mutual funds:
A close-ended mutual fund is a type of mutual fund which is known for pooling resources from different investors through thenew fund offer (NFO). Under these funds, an investor opts to purchase units of the fund during the NFO period. In these mutual funds, units are sold off at a price based on the NAV of the mutual fund that is introducing the NFO.Generally, close-ended fundsare known for raising a fixed amount of capital through NFOs. After NFO, no fresh unit can be purchased from the AMCs, but the units issued can be traded on listed stock exchanges.
How do close-ended mutual funds work?
Usually, the AMC launches an NFO. Once the asset management company issues the new fund offer, an investor purchases the units of the fund at a very specific price. Once the NFO period expires, a new investor cannot enter the fund and purchase new units. Moreover, you are prohibited fromexiting the fund before the maturity date of the scheme arrives.Typically, the maturity period is known forrangingbetween 3-4 years.
Are there any merits associated with close-ended mutual funds?
- They have a stable asset structure:
If you want to redeem your close-ended mutual fund units,you could do so only on predetermined dates, i.e., the date when the fund reaches its maturity date. This feature provides fund managers with a consistent asset base. A consistent asset base is a base that’s not vulnerable to frequent redemptions. Simply put, the managers need not worry about the frequent inflow and outflow of cash. With this, a manager can formulate an investmentstrategy that’s more comfortable for them.
- They offer both flexibility and liquidity:
While redemptions were not allowed for these funds,theyafford the investor the flexibility to sell their units as they are listed on the stock market. Therefore, you can easily liquidate your investment. The purchase and saleof units take place during any trading day.
Open-ended mutual funds:
An open-ended fund is a type of fund that’s introduced to the market once the new fund offer (NFO) ends. This type of mutual fund enables you to enter and exit the fund at any time once it is launched. Conversely, close-ended fund funds do not permit the entry and exit of investors after the expiry of the new fund offer period.
How do open-ended mutual funds work?
In these mutual funds, units are bought and sold on demand at the NAV of the fund. The NAV is known forfluctuating every day based on the prices of the bonds and stocks in the market. No limitations are imposed on the number of units of the mutual fund. Also, no maturity period is set for these funds. Once the units of an open-ended fund are redeemed, they are taken off the market. However, youare required to pay exit loads for units that are sold off within 1 year.
Are there any merits associated with open-ended mutual funds?
- These funds are highly liquid:
It is possible for you to redeem the units of your open-ended mutual fund on any working day. While there are investment options that offer good returns, they are usually accompanied by a lock-in period, meaning, you can’t redeem your investments until maturity. However, most of the open-ended funds don’t have a lock-in period.The notable exceptionsare ELSS funds (equity-linked savings scheme) and solution-oriented plans.
- A track record of the past performance is available:
Another salient feature of mutual funds nowadays is that you will be provided with a comprehensive breakdown of your investments in the mutual fund scheme. The performance track record of an open-ended mutual fund will provide insight into the fund’s historical performance, thereby helpingyou to make an informed decision.
How to distinguish close-ended mutual funds from open-ended mutual funds?
|Parameters||Close-ended mutual funds||Open-ended mutual funds|
|Fund Management||There is no pressure on the fund manager becauseyou cannot redeem the units till the end of the scheme tenure.||There is pressure on the fund manager. That’s becauseyou have the liberty to redeem money.|
|Maturity Period||They have a fixed maturity period that ranges from three to five years.||They do not come with a fixed maturity term.|
|Listings||They are listed on the stock exchange.||They are not listed on the stock exchange.|
|Fund size||The fund size of these funds remains fixed.||The fund size of these schemes remains flexible.|
|Transaction timings||The transactions are in real-time.||The transactions are carried out at the end of the day.|
|Price determination||The share prices vary based on demand and supply.||Shares are purchased and sold based on the NAV declared by the fund.|
Regardless of whether you are an amateur or an experienced investor it is important to understand and note the differences between the different types of mutual funds. After understanding the differences, you can take an informed decision.