Open ended and closed ended mutual funds

Introduction

Mutual funds are best investment avenues for investors to accumulate wealth by diversifying their investments into different mutual fund schemes. Based on their structure, mutual funds are categorized as open-ended schemes and close-ended schemes. In this article, we will read about these schemes in detail. So, read along!

What are open ended mutual fund schemes?

Open-ended mutual fund schemes are flexible schemes with no fixed maturity period since they can be issued and redeemed any time. There is no limit on the issuance of units by these schemes as these are not traded in open markets. The purchase and sale of the open-ended schemes are done based on NAV. Investors looking for liquidity can choose open ended schemes since the units of these schemes can be redeemed any time. Open ended schemes also allow investors to track the past performance of the schemes and hence investors can decide the schemes best suitable for them. The Net Asset Value (NAV) of open-ended scheme depends on the underlying value of securities of a fund therefore it is calculated daily. Mutual fund houses launch the new mutual fund schemes through the New Fund Offer (NFO). During the NFO period, investors get the fund units at the NFO price which is ₹ 10. Investors can purchase or sell units of an open-ended scheme even after the closure of NFO period. Investors can invest in these schemes either through SIP or lumpsum modes.

What are closed ended mutual fund schemes?

Going by the name, closed-ended mutual fund schemes are closed for subscription and sale after the initial subscription through New Fund Offer is over. Here, the investors can redeem their units but only on predefined dates, i.e., when the fund matures unlike the open-ended schemes where investors can redeem on prevailing NAV of the day. Also, SEBI regulations ensure that the close ended schemes give at least 1-2 avenues to the investors for entering or exiting the schemes. Close ended schemes play a major role in stabilizing the asset base of the fund because investors do not frequently redeem. Fund manager can easily derive the strategy and execute it without worrying much about the frequent inflows and outflows.

Differences between open-ended and closed-ended mutual fund schemes

What are the advantages of the open-ended mutual funds?

Liquidity

Investors have the freedom to redeem their units whenever they want which makes open ended schemes more liquid. Open ended schemes are more flexible when compared with other investment options since they allow investors to redeem at prevailing NAV.

Availability of the track record

Open Ended Schemes allow the investors to track the past performance of the fund which helps investors in making informed decisions.

Investments can be done via SIP route

In the open-ended mutual fund schemes, Investors can make regular investments through the SIP route. It helps investors who cannot afford lump sum investments. Other options like Systematic Withdrawal Plan (SWP) and Systematic Transfer Plan (STP) are also available.

What are the advantages of the closed-ended mutual funds?

Steady asset support

Close ended mutual funds do not allow the investors to redeem the units of the funds except on the prescribed dates that are usually when the fund matures, or the fund house opens the fund for redemption or purchase as per SEBI guidelines. Hence, the fund managers get a steady base of assets without the fear of inflows or outflows. They get a free hand to form a steady investment plan.

Lower expense ratios

Since closed-ended funds have fixed number of units, they do not have the ongoing costs that are associated with distributing, issuing and redeeming of the units like open-ended funds. This results in closed-ended funds having lower expense ratios comparing to open-ended funds with similar investment strategies.

Disadvantages of open-ended and closed-ended mutual funds

Tax on gains – open-ended vs closed-ended fund

The tax treatment of returns on Open ended and Close ended schemes are identical

Conclusion

It becomes difficult to suggest investors what to choose since opting a scheme depends on their financial goals. The performance of any scheme depends on the category of fund, fund manager and investment cycle. Although on a general note, investors with short term financial goals can opt open ended schemes while close ended options are better for investors who are willing to lock in amount for longer period of time. It is up to investors’ discretion to choose between open ended and close ended schemes but when it comes to liquidity and past performance record open ended mutual fund schemes score more than close ended mutual fund schemes.