Open Ended vs Closed Ended Mutual Funds

Publication Date :

19 Sep, 2017

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Table Of Contents

Open-Ended and Closed-Ended Mutual Funds Differences

An open-ended mutual fund gives utmost liberty and flexibility to investors to enter and exit as and whenever they feel like and its variation is totally dependent on the investors’ faith whereas in close-ended mutual funds offers a fixed timeline to investors for participating in and out of the fund.

A mutual fund is a professionally managed investment scheme in which the investors can have access to diversified portfolios with a mix of equities, bonds, and other securities with a limited amount of capital. Such funds are very helpful for retail investors and are also viewed as an investment opportunity over a period of time. All mutual funds are registered with their respective regulators for the securities market e.g., SEBI in India, which will offer a level of comfort to investors and prospects. They have to function within the provisions of strict regulation created to protect the interests of the investors.

One can invest in these funds by purchasing its units/shares at the existing NAV (Net Asset Value) of the fund, which is volatile depending on the performance of the stocks a part of the portfolio. The funds are managed by professional money managers who are responsible for investing the capital amount of the investors with an aim to produce Capital Gains and income for the investors. The investment is made on behalf of all the investors, and hence a lot of skills are required. The investment objectives and its structure are clearly stated in its Prospectus, which is a legal document and has to be abided by the same.

There are various types of mutual funds that can be broken down on the basis of the maturity time frame and also by investment objective.

The below diagram can give a clear snapshot of mutual funds.

Open-Ended and Closed-Ended Mutual Funds Differences

Open Ended vs Closed Ended Mutual Funds Infographics

Let’s see the top differences between open-ended vs closed-ended mutual funds.

Similarities

These funds have some basic similarities between them, which maintain the base and categorize them under mutual funds.
Both these funds are managed professionally with an aim to exceed the investments which have been made by a large pool of investors.
It aims to achieve the same through diversification in multiple investment assets rather than a single stock.
The commission or fees of the investment managers can depend on the returns they are able to garner from the market.
Another point of similarity refers to the Economies of scale, whereby gathering a large pool of funds from multiple investors enables the investment and operating costs to be lowered.

Key Differences

Open-Ended funds are popular amongst typical investors as it permits them to enter and exit at any time, thereby offering them a lot of flexibility. Close-ended funds have a fixed number of shares that are purchased from other investors and have a fixed timeline to enter and exit the fund. The New Fund offer may stay open for, say 30 days post, which no units will be exchanged.
The transactions of Open-ended funds are performed directly through the fund, whereas close-ended ones are initially launched through an IPO (Initial Public Offering) subsequent to which they are listed on the stock exchange, on the OTC market, or an Exchange Traded funds.
The corpus of an open-ended fund will keep on varying since it will involve dynamic buying and redemptions, whereas, on the other hand, the corpus remains fixed since new units are not offered for sale beyond the limit, which has been specified.
The prices for open funds are fixed once a day at the NAV (Net Asset Value), preferably at the end of the day, and are the price at which fund shares can be purchased for that day. Close-ended funds traded throughout the day like ordinary stocks and traded at the prevailing price any time during the day since it works on a real-time basis.
The structure of open-ended funds is prescribed since its inception and will largely include investments in Equities, Bonds, and Gilt-edged securities, whereas closed-ended funds will include alternative investments in its portfolio such as Futures, Derivatives, and FOREX.
The selling price of an open-ended fund involves the NAV and any entry/exit load as prescribed by the Prospectus. These loads are charges which are implemented for entering or exit the fund or both primarily for management of the funds. Close-ended funds are traded at a Premium or Discount to the NAV.
NAV’s of various funds are quoted in daily newspapers or on the website of the fund for open-ended funds. Closed-ended funds can obtain their NAV from financial newspapers or through the website on a weekly basis.
The total number of shares for each of the stocks and bonds in open-ended funds are multiplied by the closing price, and the resultant for each investment is added together. Any liabilities associated with the fund are excluded (such as accrued expenses). The NAV per share is arrived at by dividing the Total Net assets by the number of outstanding shares. Prices of shares for closed-ended funds are determined as per the demand and supply prevailing in the market, and prices would be determined accordingly on the stock market.
Open-ended mutual funds permit systematic purchases irrespective of the market conditions and also allow investments in smaller quantities, unlike closed-ended funds, which allow only lump-sum investment, making it riskier for investors to consider, especially under choppy market conditions. Trends have also suggested that closed-ended funds come up when markets are performing exceedingly well, tempting prospective investors.
Asset allocation or rebalancing is possible in the cases of open-ended funds, which consider Goal-based planning and thus understand the importance of asset allocation in an investment portfolio. The structure of the funds can be adjusted in case of a turnaround in the general market scenario. If the equity market is rising and heading saturation, one may want to redeem a portion of the same and divert the same towards debt funds. Such flexibility is not possible in a closed-ended structure. Structural changes are not permitted, and the investors would not be aware of the internal details or also the bond yields in case of a long term investment.

Open Ended vs Closed Ended Mutual Fund Comparative Table

Basis for Comparison	Open-Ended Mutual Funds	Closed-Ended Mutual Funds
Meaning	Continuous buying and selling of the units	Capital is fixed, selling a specific number of units.
Entry & Exit	Convenience as per the investors	Participation only till the NFO (New Fund Offer) is on.
Availability	Funds are not traded in the open market and get repriced based on the number of shares bought and sold. Transactions are performed directly through the fund.	They are launched through an IPO for raising money and subsequently listed like a stock or an ETF.
Price Determination	The NAV per share is arrived at by dividing the Total Net assets by the number of outstanding shares. Any additional expenses have to be reduced from the total assets.	The value is based on the NAV, but the actual price is determined by the demand and supply making it possible to trade at prices above or below the value of its holdings.
Management Style	It can be active, passive, or a combination depending on circumstances.	It follows an Active style of management.
Maturity Period	No Fixed maturity	A fixed maturity period can normally range from 2-5 years.
Publishing of NAV	Published on a daily basis	Published on a weekly basis
Profits	Profits depend on the investors, and when they exit the fund. If they have exceeded their initial investment, then it is considered as a Gain.	Profits to the shareholders can be in the form of income and capital gain distributions. It can also be capital gains realized from the sale of shares with increasing share value though it is exposed to tax liability.
Corpus	Varies depending on the confidence of the investors.	Corpus remains fixed as new units are not issued.
Selling Price	NAV plus entry or exit load as specified in the Prospectus	Traded at Premiums or Discounts to their NAV's
Trading	Purchased directly from the underwriter of the fund	Bought and sold through brokers. Brokerage firms underwrite and sell newly-issued shares.
Restrictions	Reasonable restrictions on investment in Leverage & Liquidity due to high levels of volatility and risks involved.	Fewer restrictions with respect to leverage and liquidity but strict regulatory limits would be applicable.
Minimum Investment	Smaller investment which is attractive to retail investors with limited disposable money.	Lump-sum investment is permitted.
Liquidity	Investments which can be easily liquidated	Investments are tilted towards illiquid securities that cannot get sold at the NAV within seven days.

Conclusion

Despite each of the categories having its pros and cons, the decision to make the investment rests in the hands of the investors and their investment objectives. It also depends on the risk appetite of the investor. A retail investor with a limited amount of capital will prefer an open-ended fund as it offers a lot of flexibility with relatively stable returns.

Considering an investment in closed-ended mutual funds could be a dilemma for investors who are new in the market. Since the securities within this structure sell at a premium or discount to the NAV, it requires determining the intrinsic value of the underlying security for deciding whether the investment is fruitful or not.