Mutual funds are versatile investment vehicles that can be classified into various types based on a range of criteria. On the basis of underlying assets, they can be classified into equity, debt, and hybrid funds. According to management style, they can be either actively or passively managed funds. They can even be divided into growth funds, ELSS, income funds, and index funds based on their investment objectives. But an important classification of mutual funds also occurs based on their structure, which mainly separates them into open ended and closed ended funds.
Each of these types works differently and comes with its own set of pros and cons. Let’s understand how open ended and closed ended funds differ from one another so you can make the best choices for your portfolio.
What are Open-Ended Mutual Funds?
In an open ended mutual fund, investors can buy or sell units at any time at the fund’s Net Asset Value on that particular day. This NAV depends on the value of the fund’s underlying assets and changes daily as the market prices of these assets fluctuate. These funds are offered by asset management companies, who issue more and more units as the number of investors increases. Because there is no limit to the number of units that can be created, open ended funds allow investors to easily enter or exit the scheme any time they want. This gives high liquidity and flexibility to investors.
Most schemes are open ended, so these are the most popular types of mutual funds in India. Open-ended schemes generally don’t have a lock-in period, but it’s important to check the scheme document to verify if there’s any. For example, open ended funds like Equity Linked Savings Schemes or ELSS have a lock-in period of three years, during which you cannot redeem your investment. On the other hand, some mutual funds can charge an exit load if you redeem your units before a specified period to discourage you from making short-term investments.
An open ended MF cannot be traded publicly either, so investors have to buy and sell units directly from the mutual fund company at the fund’s NAV at the end of each trading day.
What are Closed-Ended Mutual Funds?
A close ended mutual fund, on the other hand, offers a limited number of units to investors. When an AMC starts a close ended MF, they form a New Fund Offer during which a fixed number of units are issued. This initial offer allows investors to buy units directly from the fund at a specified price, which is generally set at Rs. 10 per unit. This NFO stays open only for a limited time.
The moment the NFO closes, investors can neither buy any new units nor redeem their investment until it matures. This maturity period can differ from fund to fund. That’s why closed ended funds are less flexible and liquid compared to open ended funds.
The investors can, however, trade their units on the stock exchange. This way, the ability of closed ended funds to be traded on stock exchanges is more like ETFs rather than mutual funds, and allows investors to redeem their units before the maturity period. They can be traded any time the market is open, and their price can fluctuate just like an ETF or a stock.
The price of a closed ended fund’s units depends on several factors, but mostly on supply and demand. Even though the NAV of the fund is calculated at the end of each trading day, the units of these types of funds can be sold at a discount or a premium. When they are sold at a discount, the price of a single unit is below the NAV. Similarly, when sold at a premium, investors sell their units for a higher price than the fund’s NAV. These prices are thus driven by the market, which is a special characteristic of closed ended funds.
There is a special type of closed ended fund, called the interval fund. These funds allow investors to redeem their units during specific periods, known as intervals. During these intervals, the units are bought back by the fund itself at the prevailing NAV, so they offer a bit higher liquidity compared to other kinds of closed ended funds.
Open-Ended and Closed-Ended Mutual Funds – A Comparison Table
There are many differences between a close ended and open ended mutual fund. Have a look at them below:
| Factor | Open Ended Mutual Funds | Closed Ended Mutual Funds |
| Definition | An open ended fund is a type of mutual fund that allows investors to buy or sell units at any time at the particular NAV of that day. | These are types of mutual funds that issue a fixed number of units for a limited time through a new fund offer. |
| Liquidity | Most open ended funds don’t have a lock-in period, so they offer higher liquidity to investors. Some schemes such as ELSS, however, do come with a lock-in period. | The units of a closed ended fund cannot be redeemed before the maturity period, so their liquidity is lower. They can however be traded on the stock exchange, which offers higher liquidity. |
| When Can They Be Bought? | Units can be purchased at any time. | Units can only be bought for a specific time period during the NFO. |
| Investment Options | Investment can be made through a lump sum amount or a Systematic Investment Plan (SIP). | Closed ended funds don’t offer SIPs, so investment can only be made through the lump sum route. |
| Tradability | Open ended funds cannot be traded on the stock exchange, and the units only be redeemed through the fund house. | These funds can be traded on the stock exchange like ETFs and stocks. |
| Minimum Investment Amount | Open ended funds offer more accessibility as investors can start investing with as little as Rs. 500 through SIPs. | Since investment can only be made with a lump sum amount, the entry barrier is comparatively higher for closed ended funds. |
| Investment Horizon | These types of funds continue perpetually, so there is no fixed maturity period. Investors can hold their units for as long as they’d like. | Closed ended funds do have a maturity period, which is generally between 3 to 5 years. |
| Unit Redemption | Units of an open ended fund can be redeemed at any time at the prevailing NAV. | A closed ended fund’s units can only be redeemed at maturity or through the stock exchange. |
| Selling Price | Units can only be sold at the day’s NAV. | The price of a unit can be over (premium) or under (discount) the NAV on the stock exchange. |
| Fund Manager Control | An open ended fund’s manager has to deal with daily redemptions, which limits the manager’s ability to invest fully in long-term, high-return opportunities as they have to maintain sufficient cash reserves. | In a closed ended fund, the manager has more control because the assets are stable and there is no obligation to provide liquidity on a daily basis. |
Risk Factors in Open-Ended vs Closed-Ended Funds
All kinds of mutual funds are subject to market risk. Both types of funds invest in instruments such as stocks, bonds, gold, real estate, and commodities. As the prices of these underlying assets fluctuate, the NAV of the fund changes. These changes can happen due to a variety of reasons like interest rate rises, policy changes, regulatory restrictions, geopolitical events, technological innovations, and more. With that, here are some key points regarding risks associated with open and closed ended mutual funds:
- A big difference between the two types of funds comes from liquidity. During market downturns or fund underperformance, investors holding open ended mutual fund investments can easily redeem their units. On the other hand, investors holding closed ended funds may not have this option.
- Another distinction between the two comes from pricing. Open ended funds can only be sold at the NAV. However, closed ended funds can be sold at the stock exchange at either a higher or lower price than the fund’s NAV. During market downturns, investors can even find it hard to get buyers for their closed ended investment to sell it at a fair price.
- The performance of an open ended fund can be easily tracked. Investors can analyse various factors such as historical returns, risk-adjusted returns, fund manager’s track record, and AUM to make informed investment decisions. Since closed ended funds are always NFOs, their performance tracking can be more complex. Investors have to rely on different methods to assess the associated risk before investing.
Advantages and Disadvantages of Open-Ended and Closed-Ended Funds
Just like any investment, open ended and closed ended funds have their pros and cons. Understanding them can help you choose the one more suitable for you.
Pros and Cons of Open Ended Funds
| Pros | Cons |
| Most open ended funds offer high liquidity as investors are allowed to redeem units anytime at the prevailing NAV. | Since investors can exit the fund at any time, open ended funds need to maintain high cash reserves to meet the redemption demands from investors. This means the assets under management may not be fully invested in high-return opportunities by the manager. If many investors exit at the same time due to market downturns, the portfolio can be seriously impacted. |
| These funds do not have a fixed maturity period, so investors can stay invested as long as they’d like. | Actively managed open ended funds can charge higher fees (expense ratio). |
| Open ended funds also offer investors the option to invest via SIPs, which makes them accessible to a wider number of people. SIPs have their own benefits like lower initial investment amount and rupee cost averaging. | Their returns can be lower compared to closed ended funds of the same category. |
Pros and Cons of Closed Ended Funds
| Pros | Cons |
| Closed ended funds can be traded on the stock exchange. If the demand for these rises, investors can sell them at a premium, that is, at a higher price than the fund’s NAV. | Investors can only invest during an NFO, so there is limited analysis that can be done to estimate the fund’s performance. Also, they can redeem their units when the investment matures or on the stock market, so liquidity isn’t very high. |
| Since investors are locked in for a period, fund managers don’t need to maintain cash reserves to quickly meet their redemption demands. This allows them to invest their assets in long-term opportunities. | Low demand and downturns can force investors to sell their units at a discount, meaning at a lower price than the fund’s NAV, which leads to losses. |
| Investing in closed ended funds doesn’t come with the SIP option, which means the upfront amount one needs to get started is comparatively higher. |
Conclusion
Now you may be wondering which between a close ended and open ended mutual fund is the better choice. Well, there is no clear-cut answer to that question, as suitability depends on each individual investor’s financial goals, risk tolerance, and investment horizon. Generally, open ended funds are considered to be more suitable for investors looking to prioritise liquidity or taking the SIP route. Closed ended funds are better for investors with a long-term horizon and those with no need for immediate liquidity.
Even under these categories, mutual funds can be divided into various groups such as debt, hybrid, growth, small-cap, mid-cap, and large-cap funds. Each of these funds has varying risk levels, returns, and suitability based on an investor’s goals. If you feel overwhelmed by the choices, you should consider consulting with a financial advisor before making any decisions. A financial advisor can accurately analyse your financial situation and risk appetite and give you personalised and unbiased investment advice to help you fulfil your dreams.
