If you’re familiar with mutual funds, there is a high chance you have come across these terms: “open-ended and closed-ended funds”. Usually, mutual fund investors can go in and out of their investment circle if they choose to. However, this movement depends on whether the mutual fund is open-ended or close-ended.
This article briefly explains the differences between these two terms so you know how best to design your portfolio.
What are open-ended funds?
Most mutual funds are open-ended, which means investors can choose to reclaim their unit holdings any day the market opens. If an investor requests to redeem their units by a particular time, the fund manager gives them the value of the units based on the market value at the end of the day. If the request comes in after the specified time, they will get the market value at the end of the next day. The advantage of this type of fund is that they do not have maturity dates.
A Unit represents your holding in a mutual fund scheme. It is also known as a mutual fund share.
What are closed-ended funds?
Closed-ended mutual funds are when your investments are locked for a set amount of time. Investors can only join closed-ended plans during the Initial Public Offer (IPO), and the units can only be redeemed after the lock-in period or the scheme’s duration. The point of the IPO is to raise money for investment. The funds gathered are traded in an open market like stocks. Investors cannot put out a request to reclaim their money. Hence, getting someone to buy your units may be challenging when you need to sell them urgently.
Initial Public Offer (IPO) is the first offer made by a company to the public for a subscription of its shares.
Differences between Open-Ended and Closed-Ended Funds
|1||No fixed maturity period.||The maturity period can last between 3-5 years, meaning you can only exit it at the end of the investment tenure.|
|2||Can join and exit the investment pool at any time.||The investment pool is only open at the start of the investment or during New Fund Offer (NFO).|
|3||Liquidity is an important feature of open-ended funds. And only a small amount is required to begin investing.||There’s a required amount needed to start investing at the beginning of the New Fund Offer.|
|4||Open-ended funds allow investors to diversify their portfolios, leaving space for risks.||Closed-ended funds remain closed and untouched, with no room to diversify.|
|5||The open-ended fund provides an overview of the fund’s historical performance over several market movements.|
In closed-ended funds, there is no track record. As a result, investing in closed-end funds is risky. Investors must entirely rely on the fund manager’s judgement in determining the success of the Fund.
|6||Because of the entrance and exit of investors, the asset base is constantly changing.||Due to the investor’s inability to join the Fund after the NFO period, the asset base is fixed.|
New Fund Offer (NFO) is the first subscription offer for a new mutual fund scheme launched by asset management companies (AMCs).
As we’ve seen above, the major difference between these two types of mutual funds lies in flexibility and liquidity. Investors can go into close-ended mutual funds if they are interested in saving for the long term. This is because it’s not easy to buy or sell units; they can only be traded when the investment tenure elapses, unlike open-ended investments where you can trade or put in requests at will.
Understanding these differences will help you with investing decisions. If you’re a small and low-risk investor, it’s often advisable to start with open-ended funds, and you may decide to switch to close-ended funds later on if you choose.