Mutual funds are categorized into several types such as money market funds, fixed income funds, equity funds, and balanced funds but apart from these, mutual funds are also differentiated on the basis of its structure i.e. open-ended and close-ended. In this article, we will discuss the major difference between both these terms and understand its relevance with mutual funds. Let’s discuss open-ended and close-ended mutual funds here.
Open-ended Funds vs. Close ended Funds – What’s the difference?
Open ended funds are perpetual kind of funds which basically means that once the fund is launched, it continues to exist without an end date whereas close ended funds come with a fixed duration. Closed ended funds may exist for 3 years, 5 years, 7 years etc. and usually come with a theme of investment. Open ended funds can be bought anytime, even after the closure of the NFO (new fund offer). Close ended funds can only be bought during the NFO i.e. the new fund offer. After this offer is over, you cannot invest into close ended funds. But in case of open ended funds, if the fund manager thinks he cannot handle the Assets Under Management (Asset Under Management) beyond a certain threshold, the fund house stops accepting any new investments under that fund.
In case of open ended funds, as continuous buying is possible, continuous selling of funds is also possible which in turn affects your asset under management (AUM) and so the AUM of the open ended funds goes up or down due to continuous investment and redemptions and also due to the change in the value of the underlying securities. In case of close ended funds, any new investment is not possible after the closure of the NFO and redemption is not a possibility in case of close ended funds unless the duration of the fund is over and so the total number of outstanding units of a close ended fund always remains same. AUM goes up or down purely due to the change in the value of underlying securities and not due to the continuous buying and selling of the fund units.
In case of close ended funds of fixed assets under management, offers great amount of flexibility to the fund manager. They can take tough long term calls to satisfy the investment objective of a fund in a better manner. They can invest into undervalued stocks which have lower liquidity and can follow a buy and hold approach. In that comparison, a variable AUM (asset under management) due to continuous investment and redemption remains a concern for the fund manager of an open ended fund and this is also the precise reason why open ended funds are more investor friendly as they offer anytime investment and anytime redemption.
To cater the redemption requests in open ended funds, the fund managers have to maintain a certain cash reserve. This is not a requirement for close ended funds as the number of units always remains constant. As redemption is not a possibility before the end of duration in close ended funds, to offer some amount of liquidity to its investors, these funds get listed on the stock exchange and there they can be traded like other stocks. But it is not as easy as it sounds.
The buying and selling of such units is purely based upon the demand and supply equation which is influenced by fund’s performance and other market conditions. And so, the fund units may trade at a premium or at a discount on the exchange. Units of open ended funds can be bought or sold at the prevailing NAV (net asset value) and thus buying and selling can be done only with the fund house. Whereas close ended funds can be bought in the NFO period from the fund house and can be redeemed only after the completion of the duration of the fund and meanwhile can be traded on the exchange, subject to demand and supply.
As anytime buying and selling is possible in case of open ended funds, you yourself have to keep your emotions at bay to stay invested through the ups and downs of the market cycle, whereas in case of close ended funds, the lock-in period helps you stay invested. Systematic investment transfer and withdrawal is a possibility in open ended funds but these are not possible in close ended funds as lump-sum investment is required which may not be possible for everyone. Redemption is not a possibility in case of close ended funds while a charge of up to 2% can be levied in case of open ended funds if the investor wants to exit early. This charge is mainly levied to discourage the investors from early exit.