Open Ended vs Close Ended Mutual Funds – A mutual fund is a professionally managed investment scheme in which the investors can have access to diversified portfolios with a mix of equities, bonds and other securities with a limited amount of capital. Such funds are very helpful for retail investors and are also been viewed as an investment opportunity over a period of time. All mutual funds are registered with their respective regulators for securities market e.g. SEBI in India which will offer a level of comfort to investors and prospects. They have to function within the provisions of strict regulation created to protect the interests of the investors.
One can invest in these funds by purchasing its units/shares at the existing NAV (Net Asset Value) of the fund which is volatile depending on the performance of the stocks a part of the portfolio. The funds are managed by professional money managers who are responsible to invest the capital amount of the investors with an aim to produce Capital Gains and income for the investors. The investment is made on behalf of all the investors and hence a lot of skills are required. The investment objectives and its structure are clearly stated in its prospectus which is a legal document and has to be abided by the same.
There are various types of Mutual Funds which can be broken down on the basis of Maturity time frame and also by Investment Objective.
The below diagram can give a clear snapshot of Open ended and closed ended mutual funds.
In this article, we shall learn in-depth about Open Ended and Close Ended Mutual Funds.
- Open Ended vs Close Ended Mutual Funds [Infographics]
- Open Ended Mutual Funds
- Close Ended Mutual Funds
- Open Ended vs Close Ended Mutual Funds – Similarities
- Key Differences – Open Ended vs Close Ended Mutual Funds
- Points to Consider
- Open Ended vs Close Ended Mutual Funds [Comparison Table]
Also, if you are new to Mutual funds, you may check out these articles
Open Ended vs Close Ended Mutual Funds [Infographics]
Below infographics highlights top 14 differences between Open ended vs close ended mutual funds.
Open Ended Mutual Funds
These funds are a collective investment scheme in which the investors can buy and redeem the shares at any point of time with a limited amount of investment. Such funds are targeted for the small-scale and retail investors. The transactions for the fund are performed directly through the fund and the share pricing is done basis the number of shares bought and sold.
The NAV for the same is published on a daily basis and a monthly/quarterly statement is provided to the investors indicating the performance of the fund. The securities in these funds are generally more liquid and can be disposed of in the market with relative ease. The NAV for such funds is calculated as:
Fund’s Assets minus Liabilities (any additional expenses to be reduced)
Total Number of Outstanding Shares
Most of these funds have an active management style since the fund manager will have to buy and sell on a regular basis in order to maximise the returns depending on the performance of carious companies in a sector. They are also required to be mindful to maintain the strategies which have been promised as per the prospectus.
Some of these funds may impose a charge on the purchase of shares or units. An ‘entry load’ may be charged while purchasing some units and on the other hand, an ‘exit load’ may also be imposed while selling of units. A few instances of open-ended mutual funds are:
- Birla Sun Life Asset Allocation Funds
- The Vanguard Group’s S&P 500
- Rowe Price
Close Ended Mutual Funds
These funds are also a collective investment vehicle managed by a fund manager responsible for maximising the returns for the amount of capital invested by the investors. However, it raises the prescribed amount of capital only once through the NFO (New Fund Offer)/IPO through a fixed number of units. They subsequently get listed on the stock exchange or an ETF. The stock price of such a fund shall fluctuate depending upon the Demand and supply forces making it possible for trading over and below the market holdings. Hence, the NAV keeps on changing during the day and it gets published on a weekly basis to have a stable understanding as the fund can be trading on a Premium or a Discount.
The Corpus of the fund does not change and it allows only a lumpsum investment from the investors. Such funds require a brokerage account for trading of the shares and the strategy can be tilted towards relative less liquid securities which cannot be traded for immediate and large amount of liquidity. A couple of popular close ended mutual funds are:
- Eaton Vance Tax-Managed Global Diversified Equity Income Fund
- Reliance Close-end Mutual Fund Series B Growth
Open Ended vs Close Ended Mutual Funds – Similarities
These funds have some basic similarities between open ended and closed ended mutaul funds which maintain the base and categorizing them under mutual funds. Both these funds (closed and open ended mutual funds) are managed professionally with an aim to exceed the investments which have been made by a large pool of investors. It aims to achieve the same through diversification in multiple investment assets rather than a single stock. The commission or fees of the investment managers can depend on the returns they are able to garner from the market.
Another point of similarity refers to the Economies of scale whereby gathering a large pool of funds from multiple investors enables the investment and operating costs to be lowered.
Key Differences – Open Ended vs Close Ended Mutual Funds
Here are the key differences between open ended and closed ended mutual fund.
- Open Ended funds are popular amongst typical investors as it permits them to enter and exit at any time thereby offering them lot of flexibility. Close-ended funds have a fixed number of shares which are purchased from other investors and have a fixed timeline to enter and exit the fund. The New Fund offer may stay open for say 30 days post which no units will be exchanged.
- The transactions of Open-ended funds are performed directly through the fund whereas close-ended ones are initially launched through an IPO (Initial Public Offering) subsequent to which they are listed on the stock exchange, on the OTC market or an ETF (Exchange Traded funds).
- The corpus of an open-ended fund will keep on varying since it will involve dynamic buying and redemptions whereas on the other hand the corpus remains fixed since new units are not offered for sale beyond the limit which has been specified.
- The prices for open funds are fixed once a day at the NAV (Net Asset Value) preferably at the end of the day and are the price at which fund shares can be purchased for that day. Close-ended funds trade throughout the day like ordinary stocks and traded at the prevailing price any time during the day since it works on a real-time basis.
- The structure of open-ended funds is prescribed since its inception and will largely include investments in Equities, Bonds and Gilt-edged securities whereas close-ended funds will include alternative investments in its portfolio such as Futures, Derivatives and FOREX.
- Selling price of an open-ended fund involves the NAV and any entry/exit load as prescribed by the prospectus. These loads are charges which are implemented for entering or exit the fund or both primarily for management of the funds. Close-ended funds are traded at a Premium or Discount to the NAV.
- NAV’s of various funds are quoted in daily newspapers or on the website of the fund for open ended funds. Close ended funds can obtain their NAV from financial newspapers or through the website on a weekly basis.
- The total number of shares for each of the stocks and bonds in open ended funds are multiplied by the closing price and the resultant for each investment is added together. Any liabilities associated with the fund are excluded (such as accrued expenses). The NAV per share is arrived at by dividing the Total Net assets by the number of outstanding shares. Prices of shares for close ended funds are determined as per the demand and supply prevailing in the market and prices would be determined accordingly on the stock market.
- Open ended funds permits systematic purchases irrespective of the market conditions and also allows investments in smaller quantities unlike close ended funds which allows only lump sum investment making it riskier for investors to consider especially under choppy market conditions. Trends have also suggested that close ended funds come up when markets are performing exceedingly well tempting prospective investors.
- Asset allocation or rebalancing is possible in the cases of open ended funds which consider Goal based planning and thus understand the importance of asset allocation in an investment portfolio. The structure of the funds can be adjusted in case of turnaround in the general market scenario. If the equity market is rising and heading saturation, one may want to redeem a portion of the same and divert the same towards debt funds. Such flexibility is not possible in a close ended structure. Structural changes are not permitted and the investors would not be aware of the internal details or also the bond yields in case of a long term investment.
Points to Consider – Open Ended and closed Ended Mutual Funds
Some general pointers to be considered before plunging to a conclusion on open ended and closed ended mutual funds are:
- The past performance of a fund should not be considered as a benchmark. There are several macroeconomic factors which are involved in the performance of a market/fund and it is not essential that a consistency shall be maintained. It could be used as a reference point. Most successful funds would also have a faced a downturn at some point which could be due to the portfolio mix or a larger macroeconomic factor such as Political or Economical. Hence, one should maintain caution before taking considering investment in a hot fund.
- The amount of fees can reduce the returns expected. This could be due to the high management fees, switching fees or other ‘load’ (entry, exit or both) charges imposed. The fee schedule needs to be studied carefully before buying a fund.
- One should also carefully check if there are any ETF (Exchange Traded Funds) for a particular mutual fund. ETF’s have grown substantially in the past few years due to multiple benefits such as Immediate liquidity, lower fees, multiple choices and less trading spreads.
- Close ends funds can also have trading costs against them which could be because of larger spreads on bid-ask rates of less liquid funds. Additionally, the possibility of an unstable discount/premium to the NAV would also be likely to exist. For instance if a share of a close ended fund is purchased for $90 representing 10% discount to the NAV of $100. If the NAV goes up to $110 but on the other hand discount spreads to say 20%, then the share would be priced at $88 ($110 – $22) which is lower than the initial price of $90. Hence, one should check the bid-ask spread and also a long term trend of the fund’s premium and discount to the NAV.
Open Ended vs Close Ended Mutual Funds [Comparison Table]
|BASIS FOR COMPARISON||OPEN ENDED MUTUAL FUNDS||CLOSE ENDED MUTUAL FUNDS|
|Meaning – Open Ended vs Close Ended||Continuous buying and selling of the units||Capital is fixed selling a specific number of units.|
|Entry & Exit||Convenience as per the investors||Participation only till the NFO (New Fund Offer) is on|
|Availability||Funds are not traded in the open market and get repriced based on the amount of shares bought and sold. Transactions are performed directly through the fund.||They are launched through an IPO for raising money and subsequently listed like a stock or an ETF.|
|Price Determination – Open Ended vs Close Ended||The NAV per share is arrived at by dividing the Total Net assets by the number of outstanding shares. Any additional expenses have to be reduced from the Total assets.||The value is based on the NAV but the actual price is determined by the demand and supply making it possible to trade at prices above or below the value of its holdings.|
|Management Style||It can be active, passive or a combination depending on circumstances.||It follows an Active style of management.|
|Maturity Period||No Fixed maturity||Fixed maturity period which can normally range from 2-5 years.|
|Publishing of NAV||Published on a Daily basis||Published on a Weekly basis|
|Profits – Open Ended vs Close Ended Mutual Funds||Profits depend on the investors and when they exit the fund. If they have exceeded their initial investment, then it is considered as a Gain.||Profits to the shareholders can be in the form of income and capital gain distributions.
It can also be capital gains realised from sale of shares with increasing share value though it is exposed to tax liability.
|Corpus||Varies depending on the confidence of the investors.||Corpus remains fixed as new units are not issued|
|Selling Price||NAV plus entry or exit load as specified in the Prospectus||Traded at Premiums or Discounts to their NAV’s|
|Trading – Open Ended vs Close Ended Mutual Funds||Purchased directly from the underwriter of the fund||Bought and sold through brokers. Brokerage firms underwrite and sell newly-issued shares|
|Restrictions – Open Ended vs Close Ended Mutual Funds||Reasonable restrictions on investment in Leverage & Liquidity due to high levels of volatility and risks involved.||Fewer restrictions with respect to leverage and liquidity but strict regulatory limits would be applicable.|
|Minimum Investment||Smaller investment which is attractive to retail investors with limited disposable money.||Lump sum investment is permitted.|
|Liquidity – Open Ended vs Close Ended Mutual Funds||Investments which can be easily liquidated||Investments are tilted towards illiquid securities that cannot get sold at the NAV within 7 days.|
Despite each of the category having its pros and cons, the decision to make the investment rests in the hands of the investors and their investment objectives. It also depends on the risk appetite of the investor. A retail investor with limited amount of capital will prefer an open ended fund as it offers a lot of flexibility with relatively stable returns.
Considering an investment in close ended mutual funds could be a dilemma for investors who are new in the market. Since the securities within this structure sell at a premium or discount to the NAV, it requires determining the intrinsic value of the underlying security for deciding whether the investment is fruitful or not.
Investors should consult their financial advisers and study the prospectus of various mutual funds before making any kind of commitments. The funds state in detail the investment objectives and sectors in which investments will be made. This offers substantial clarity to prospective investors which have to be synced with their individual financial objectives and resources to consider the investment.