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Mutual funds are differentiated based on their structure i.e open-ended and closed-ended. The difference between the two types of funds is a function of flexibility and ease of sale and purchase of fund units.

This article covers the following:

  1. Close-Ended Mutual Funds
  2. Advantages of Close-Ended Funds
  3. Disadvantages of Close-Ended Funds
  4. Open-Ended  Mutual Fund
  5. Advantages of Open-Ended Funds
  6. Disadvantages of Open-Ended Funds
  7. Comparison Between Open-End and Closed-End Mutual Funds.

 

1. Close-Ended Mutual Funds

Close Ended fund issues a fixed number of shares that are traded on the stock exchange. It functions much more like an exchange-traded fund than a mutual fund. They are launched via IPO to raise money and then traded in the open market just like a stock. Though the value of the fund is based on the NAV, the actual price of the fund is affected by supply and demand as it is allowed to trade at prices above or below its actual or real value. Hence, closed-end funds can trade at premiums or discounts to their NAVs. Shares of closed-end funds are bought and sold through brokers. Closed mutual funds usually trade at discounts to their underlying asset value. These funds have a fixed maturity period.
 

2. Advantages of Close-Ended Funds

a. Stable Asset Base

In Closed-ended funds, the investors are not allowed to redeem units of the fund except on the prescribed dates i.e. when the maturity of the fund expires. In this way, portfolio managers get a stable base of assets which is not subject to frequent redemptions. The main advantage of a stable asset base is that the fund manager is in a comfortable position to formulate an investment strategy keeping in mind fund objectives holistically and without having to worry about the inflows and outflows.

b. Availability of Market Prices

Closed-ended funds trade on stock exchanges like equity shares. This provides an opportunity to the investors to buy/sell units of the fund based on real-time prices which can be above (premium) or below (discount) the fund’s NAV. They can make use of usual stock trading strategies like market/limit orders and margin trading.

c. Liquidity and Flexibility

Investors are free to avail liquidity offered by the fund. They may utilize real-time prices available during the trading day to buy/sell closed-end fund units at prevailing market prices. They get the flexibility to decide on their investments by using real-time information.

 
Close-Ended and Open-Ended Funds
 

3. Disadvantages of Close-Ended Funds

a. Poor Performance

Performance of the Closed-ended schemes has not been at par as compared to their open-ended peers across time horizons. You may know that the fund manager is in the favorable position due to restriction on redemptions. The lock-in period levied in closed-end funds which are aimed at giving the fund managers the flexibility to allocate the money without the fear of outflows has not helped much in generating better returns.

b. Lump Sum Investment

Close-ended funds require you to invest a lump sum to buy the units of the fund at the time of their launch. This can be indeed a risky approach to deal with your investments. It exposes you to take bigger bets than otherwise warranted. Moreover, a large number of salaried class of investors are unable to afford lump sum investments. They, instead, prefer staggered investments by way of systematic investment plans (SIP).

c. Non-Availability of Track Record

In case of an open-ended fund, you are able to see the performance of the fund over different market cycles on account of availability of historical data. However, in case of close-ended funds, the track record is not available. Hence, investing in a closed-ended fund is infested with uncertainties and you can only depend on the fund manager.

 

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4. Open-Ended  Mutual Fund

Open-end funds are what you know as a mutual fund. Open-end funds do not trade on the open market. They don’t have a limit as to how many shares they can issue. The NAV changes daily because of market fluctuations of the shares or stocks and bond prices in the fund. Open-end mutual fund shares are bought and sold on demand at their net asset value or NAV which is dependent on the value of the fund’s underlying securities and is estimated at the end of every trading day. Investors buy shares directly from a fund. The investments of the open-ended fund are valued at the fair market value which is also the closing market value of listed public securities. These funds also do not have a fixed maturity period.
 

5. Advantages of Open-Ended Funds

a. Liquidity

Open-ended funds offer high liquidity because you are able to redeem units of the fund as per your convenience. As compared to other types of long-term investments, which can be highly illiquid, open-ended funds offer the flexibility of redemption at the prevailing net asset value (NAV).

b. Availability of track record

In case of a close-ended fund, you are not able to see the performance of the fund over different market cycles on account of non-availability of track record. However, in case of open-ended funds, historical performance of the fund is available. Hence, investing in an open-ended fund is a well-informed decision.

c. Systematic Investment Plan

Close-ended funds require you to invest a lump sum to buy the units of the fund at the time of their launch. This can be indeed a risky approach to deal with your investments. It exposes you to take bigger bets than otherwise warranted. However, open-ended funds is a suitable investment option for a large number of salaried class of investors. It is because they can initiate systematic investment plans (SIP) into the fund of their choice.
 

6. Disadvantages of Open-Ended Funds

a. Suffers from Market Risk

Even though the fund manager of open-ended funds maintains a highly diversified portfolio, they suffer from market risks. The NAV of the fund keeps fluctuating according to the movements of the underlying benchmark.

b. No say in asset composition

Open-ended funds appoint fund managers who are well-qualified and have experience in the field of fund management. They take all the decisions as regards selection of securities for the fund. Hence, the investors do not have a say in deciding asset composition of the fund.
 

7. Comparison Between Open-End and Closed-End Mutual Funds

It is difficult to say whether open-end funds are better than closed-end funds or vice versa. The performance of a fund whether open-ended or closed-ended depends on the fund category, fund management & investment style.

Some open-end fund investors are quick to redeem their units after the NAV appreciates by 5 – 10% to book short-term profits. This hurts the investors who remain invested in the funds. Closed-end funds are better options in such situations because the lock-in period prevents early redemptions and protects the interest of long-term investors.

Close-ended funds can be useful for someone who has less or no knowledge of the markets and desires an annualized return of 15 – 20%. As these funds are managed by professionals and experts, with the NAV being updated daily and highly liquid these get a slightly more advantage for investors than the close-ended funds.

 

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