Key differences between open-ended and close-ended mutual funds (2024)

When you invest in mutual funds, you become a part-owner in the investment portfolio. Based on their structure, mutual funds are classified as open-ended or closed-ended.

According to the Association of Mutual Funds in India (AMFI), in India, mutual funds account for only 11 percent of the GDP (equity 4 percent and debt 7 percent), while the global average is 62 percent. This demonstrates that India's mutual fund business still has much room for growth.

A New Fund Offer kicks off every mutual fund (NFO). If an investor applies for a mutual fund scheme, they will receive fund units at the NFO price. An open-ended fund is created after the NFO has finished. It allows investors to join and leave the fund after it has been established.

In India, mutual funds are divided into two types based on their investing structure: they are either open-ended or closed-ended. So, before moving to the differences, let's understand what open-ended and close-ended mutual funds mean.

What are open-ended mutual funds?
When you hear the term, you are not altogether wrong if you think of an open-end fund as a mutual fund. Since a mutual fund is a form of an open-ended fund, this is the case. Three Hedge funds and exchange traded funds (ETFs) are examples of open-end investments. These are made available through equity funds, which sell shares from each investor directly. Outside of the United States, open-ended funds are SICAVs in Europe and OEICs or unit funds in the United Kingdom.

During the day, open-ended funds are traded at times set by fund managers. Open-ended funds have no limit on the number of shares they may issue, implying that shares are limitless. As long as there is interest in the fund, shares will be issued. As a result, when investors purchase new shares, the investment company produces new ones to replace them.

Open-ended funds' prices are set at their NAV once a day and reflect the fund's performance. The fund's assets are subtracted from its liabilities to arrive at this figure. On that particular day, it's the only price during which fund shares could be acquired.

Advantages of open-ended mutual funds

• An open-ended mutual fund has a good level of liquidity, allowing you to redeem your units whenever you choose. In contrast to other forms of long-term investments, open-ended funds allow for redemption at the current Net Asset Value (NAV).
• The fund's past performance is available in the case of open-ended funds. As a result, investment in an open-ended fund is a wise choice.
• For many salaried individuals, open-ended funds are a viable investment alternative. It's because they could invest through a Systematic Investment Plan (SIP).

Disadvantages of open-ended mutual funds

• Open-ended funds are vulnerable to market risks, even if the fund manager maintains a well-diversified portfolio. The fund's NAV fluctuates in response to the changes in the underlying benchmark.
• Fund managers are appointed by open-ended funds to make all decisions about purchasing securities for the fund. As a result, the investors have no input in the asset composition of the fund.

What are close-ended mutual funds?
Your investment in closed-ended mutual funds is locked in for a set time. Close-ended plans can only be subscribed during the new fund offer period (NFO), and the units may only be redeemed once the lock-in period or the scheme's term has expired.

According to the Association of Mutual Funds in India (AMFI), closed-end schemes' total assets under management (AUM) are roughly 9.5 percent of open-ended schemes' AUM, which is Rs 20.07 trillion (as of September 30, 2018).

However, some closed-ended funds become open-ended once the lock-in period expires, or the AMCs may transmit the proceeds of closed-ended funds to another open-ended fund after the maturity term. However, this requires the approval of the closed-ended fund's investors.

Though the NAV determines the fund's value, the fund's actual price is determined by supply and demand. Thus, it may trade at prices above or below its actual value. As a result, closed-ended funds can trade at a premium or a discount to their net asset values (NAVs). Brokers are used to buying and selling closed-ended fund units.

Close-ended mutual funds trade at a discount to the value of their underlying assets. These funds have a set maturity date as well.

Advantages of close-ended mutual funds

• Investors in closed-ended funds can only redeem their units on predetermined dates, such as when the fund matures. This provides portfolio managers with a consistent asset base that is not prone to periodic redemptions. A steady asset base makes it easier for the fund manager to create an investment plan. In the case of stable asset bases, fund managers could also keep the fund's overall objectives in mind without worrying about inflows and outflows.
• Closed-ended funds, like equity shares, are traded on stock exchanges. This allows investors to buy and sell fund units based on real-time values that may be higher (premium) or lower (discount) than the fund's NAV.
• Investors could liquidate closed-ended funds according to the fund's rules. They could buy and sell closed-ended fund units at market prices using real-time pricing accessible during the trading day.

Disadvantages of close-ended mutual funds

• The lock-in period of closed-ended funds, which is supposed to give fund managers more flexibility in allocating funds without fear of outflows, hasn't helped much in improving returns.
• Closed-ended funds require adding a one-time investment when they first begin trading. This may not always be a prudent way to handle your investments.
• The track record is not provided in the case of closed-ended funds. As a result, investment in a closed-ended fund has risks that you can only rely on the fund manager to mitigate.

Differences between open-ended and close-ended mutual funds
It's impossible to conclude whether open-ended are better than closed-ended funds. Irrespective of whether a fund is open-ended or closed-ended, its success is determined by its category, management, and investment strategy. Here are a few differences between open-ended And close-ended mutual funds.

Redemption Pressure: The fund manager should maintain liquidity in both open-ended and closed-ended mutual funds, and these assets may produce suboptimal returns on occasion. It has the potential to reduce the fund's return. During periods of acute market turbulence, redemption pressure might become critical. One of the benefits of a closed-ended fund is that the fund manager could take a long-term approach by investing in an asset that might create good long-term returns because there is no redemption pressure from market sell-offs.

Availability: Open-ended funds may be bought and sold at any time, but closed-ended funds could only be purchased during NFOs (New Fund Offerings) or from the stock exchange after they have been listed. On the other hand, an open-ended fund remains open for subscription long after the NFO has closed, and the units may be redeemed whenever the investors desire.

Furthermore, a closed-ended plan liquidates once the maturity date has passed, and the funds are paid to subscribers depending on their holdings. After maturity, closed-ended funds may only be changed into open-ended funds in a few cases.

Fixed Corpus: Close-ended funds have a fixed corpus and a term that usually ranges from three to five years, whereas open-ended funds may not have a fixed maturity or corpus. If you want to invest in a closed-ended fund, you should be willing to put your money aside for a set amount of time. On the other hand, an open-ended fund allows you to buy and sell whenever you desire. The corpus of an open-ended fund changes due to constant buying and selling, but the corpus of a closed-ended scheme is fixed at a specified limit.

Buying and Selling Units: The number of outstanding shares in open-ended mutual funds constantly fluctuates due to the fund house's constant selling and repurchasing of units in response to investor requests. Units of closed-ended funds are traded on exchanges after the conclusion of a new fund offer (NFO), which is similar to an initial public offering (IPO) in the stock market, wherein investors may subscribe to the issue for the first time. Buying and selling closed-ended fund units is nearly identical to buying and selling equities. To know how much returns you will get from selling a unit, use the Axis Bank Mutual Fund calculator.

Tax Benefits: There is no tax benefit from investing in an open-ended mutual fund for total income deduction. An investment in an Equity Linked Saving Scheme (ELSS), a closed-ended mutual fund, provides a tax benefit of up to Rs 1,50,000 under section 80C of the Income Tax Act, 1961.

Unit Price: The NAV, announced by the AMC at the end of a business day at 8 p.m., is the price at which an investor buys or sells shares of an open-end mutual fund. Closed-ended funds' units may trade at a premium or discount to NAV depending on investors' expectations with respect to the fund's future performance and prospects. If numerous investors want to buy shares of a closed-ended fund but only a few units are available for sale, an investor may be ready to sell his units for a higher price than the current NAV.

Changes in Unit Capital: Due to prominent, frequent transactions, open-ended funds are needed to sell or repurchase units at the investor's request at any moment. The fund's unit capital does not remain constant. In the case of closed-ended funds, the fund's unit capital remains the same after the NFO because the number of total outstanding units remains the same, regardless of whether those units are traded on exchanges.

Requirement of Demat Account: An investor does not require a Demat account to purchase or sell open-ended fund units through a fund house. An investor must open a Demat account and execute transactions through a broker or financial advisor to trade the units of a closed-ended fund following the NFO.

Transaction Charges: For open-ended funds, an investor who buys or sells units through a fund house does not have to pay a separate brokerage fee. In the case of closed-ended funds, an investor who buys or sells units through a stock exchange will almost certainly produce a sales commission to the broker at the time of the transaction.

Bottom Line
There are other technical differences which exist between the two types of funds, but the above are the most important ones to consider when deciding whether one should invest in closed-ended or open-ended mutual funds or both.

It's impossible to conclude if open-ended funds are better than closed-ended funds or vice versa. Whether open-ended or closed-ended, a fund's success is primarily determined by its category, management, and investment strategy.

To record short-term profits, some open-ended fund investors are ready to redeem their units after the NAV rises by 5 percent to 10 percent. This is bad news for investors who have stayed loyal to the fund. In such cases, closed-ended funds are preferable since the lock-in period inhibits early redemption and safeguards the interests of long-term investors.

Open-ended funds can be beneficial to someone with little or no experience in the markets looking for a 12 percent to 15 percent annualized return. Since professionals and specialists manage these funds, the NAV is updated daily and is very liquid. They have a modest edge over closed-ended funds for investors. Thus, find out the best mutual funds with the help of Axis Mutual Fund Online Investment, where you can see the returns you would be getting for each investment.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.Disclaimer:
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