Difference Between Open Ended and Closed Ended Mutual Funds

Mutual funds are classifiable based on how they are structured. Whether they are open-ended or closed-ended mutual fund schemes depends on the structure. Function, adaptability, and the simplicity of buying and selling fund units serve as the main points of differentiation between these two categories of mutual funds.

Through a New Fund Offer (NFO), a mutual fund house introduces investors to a mutual fund scheme. If the NFO period is in effect, investments in mutual fund schemes are permitted. Additionally, after the term ends, both new and existing investors are not permitted to make any more acquisitions. Understanding the differences between mutual funds is made simpler by the NFO idea.

What are Open Ended Mutual Funds

Mutual funds are also referred to as open-ended funds. These funds are not exchanged openly. They can release an unlimited number of units, nevertheless. Due to fluctuations in the bond and equity markets, the NAV is subject to daily revisions.

Units in open-ended mutual funds are exchanged on order at their Net Asset Value, or NAV, which is computed at the conclusion of each trading day based on the underlying securities of the fund. Investors purchase units straight from a fund.

Investments in open-ended funds are evaluated at fair market value, which also happens to be the closing market value of publicly traded securities. The funds are also unrestricted.

Open-ended mutual funds are a good option for investors looking for high liquidity because they don't have a maturity time or limits on the quantity of units an investor can buy or redeem. Nevertheless, when you redeem the units of open-ended schemes, there can be an exit burden.

Benefits of Open-Ended Mutual Funds

Extremely Liquid

An open-ended fund's units may be redeemed by investors on any business day. This gives your investment portfolio the extra liquidity it needs. Even if there are plenty of investment options with high returns on offer, many of them have lock-in periods that make your money unusable until they mature. Enjoy optimum liquidity with open-ended mutual funds.

Performance Throughout Various Market Cycles

An open-ended fund allows investors to buy or redeem units from the fund house; hence, a cursory review of the fund's past performance can provide insight into how it has fared in various market cycles. This enables you to invest in line with your goal and make well-informed decisions.

SIP's Accessibility

You can set up a systematic investment plan, or SIP, to regularly invest a specific amount in the scheme as you can buy units on any working day. Those on salaries and those without a readily investable corpus stand to gain the most from this. Additionally, you can start from scratch while building a corpus with SIP investments.

Drawbacks of Open-Ended Mutual Funds

High Volatility

An open-ended mutual fund's NAV varies based on how well the underlying securities perform. As a result, open ended funds are extremely volatile and vulnerable to market risks. These funds always carry a certain amount of market risk, even though the fund manager tries to reduce volatility by diversifying his holdings.

Massive Withdrawals and Inflows

Unlike closed-ended funds, open-ended plans are susceptible to large inflows and withdrawals. Investors in the program could all lose money if a fund manager sells units at a loss due to a rapid outflow.

Cash Flow Hazards

Cash flow and market risk also affect open-ended funds. These funds' NAV varies every day in response to fluctuations in the market.

Who Should Invest in Open Ended Mutual Funds?

Most mutual funds on the market are open-ended funds. As a result, open ended funds are accessible to most investors.

All they must do is make investments based on their investment horizon, risk tolerance, and financial objectives.

What are Closed Ended Mutual Funds

A fixed number of fund units are traded on stock exchanges for closed-ended mutual funds. Compared to mutual funds, closed-ended funds function like exchange-traded funds (ETFs). Like stocks, they are released through a new fund offer (NFO) to generate capital and are traded on the open market.

Although the NAV determines the fund's value, supply and demand determine the fund's real price. As a result, its trading price may differ from its actual value.

Closed-end funds may therefore trade above or below their net asset values (NAVs). Brokers have experience purchasing and selling units of closed-ended funds. Closed mutual funds have a specified maturity period and trade at a premium to the value of their underlying assets.

Investors may opt to sell their units on the open market to withdraw from the plan. It could take some time and work to find a seller for your chosen price, though, because of the closed-ended structure and restricted liquidity.

A buyback option is provided by certain closed-ended funds after a predetermined period. Moreover, it gives investors a way out prior the maturity date.

Benefits of Close Ended Mutual Funds

Stability for Fund Managers

The asset base available to fund managers is fixed because investors in closed-ended funds are not allowed to redeem their units prior to the fund's maturity date. The fact that there are no refunds means they are not concerned about keeping liquidity. This places the fund manager in a strong position to develop a plan that will enable him to meet the scheme's investment goals.

Market Pricing Determined by Supply and Demand

Similar to equity shares, closed-ended scheme units are traded on the stock exchange at rates that are set by the scheme's supply and demand. Therefore, units in each closed-ended scheme may sell for a price significantly higher than the plan's net asset value (NAV) if demand for the scheme grows and supply stays limited.

They Do Not Lack Liquidity

Although closed-ended funds don't enable unit redemptions, which may make them appear illiquid at first glance, there are several possibilities to acquire and sell units on the stock exchange. Investors can obtain a high level of liquidity through closed-ended funds. A closed-ended fund's units can be purchased or sold on the stock exchange at the going rate.

Who Should Invest in Close Ended Mutual Funds

Closed-ended funds don't allow redemptions until after they mature and require a lump sum deposit. For this reason, closed-ended mutual funds are an option for investors whose investible corpus coincides with the scheme's maturity date. In addition, the offer document's asset allocation for the plan should be used to evaluate the risks and rewards.

Drawbacks of Close Ended Mutual Funds

Not The Best Performance in The Past

A closed-ended fund's fund manager is well-positioned to develop investment strategies that will enable him to meet the scheme's investment goals. But if we compare closed-ended funds' historical performance to open-ended schemes, it doesn't appear to show superior returns.

There Is Only One Investment Option Available: Lump Sum.

You must invest in full because you can only buy units in a closed-ended scheme during its initial launch period. Risk rises as a result. Additionally, because the systematic investment plan (SIP) strategy is less expensive and spreads risk, it is preferred by many investors.

Highly Fund Manager Driven

When deciding whether to invest in a mutual fund scheme, investors typically examine the plan's performance over various market cycles. Although this data is easily accessible for open-ended schemes, it is not available for closed-ended funds. Therefore, the fund manager's decisions have a significant impact on the fund's success.

Difference Between Open-Ended and Closed-Ended Mutual Funds

Conclusion

Investors need to comprehend the distinctions between open-ended and closed-ended mutual funds to make well-informed investing choices. Many investors find open-ended funds appealing because they offer flexibility, liquidity, and a large selection of investment possibilities.

Closed-ended funds, on the other hand, provide specialized investment options but may have premiums or discounts in addition to limited liquidity. When deciding between these two mutual fund kinds, investors should ultimately take their time horizon, risk tolerance, and investing goals into account.