Mutual funds are classified according to their structure, such as whether they are open-ended or close-ended. The distinction between the two types of funds comes down to flexibility and the simplicity with which fund units can be sold and purchased.
What Are Open-Ended Funds?
The term "open-ended fund" refers to what is commonly referred to as a mutual fund. These funds do not trade on a public exchange. They have no limit on the number of units they can distribute. Because of stock market volatility and the fund's bond values, the NAV changes every day.
The NAV of open-ended Mutual funds is computed after each trading day and is based on the value of the underlying securities. Investors buy units in a mutual fund directly. The closing market value of listed public securities is the same as the fair market value of open-ended funds' assets. These funds, too, do not have a defined maturity date.
Benefits of Open-Ended Funds
- Availability of Track Record: Due to the lack of a track record in the case of a close-ended fund, you are unable to compare the fund's performance over market cycles. In the case of open-ended funds, however, the fund's past performance is available. As a result, investing in an open-ended fund is a wise choice.
- Liquidity: Open-ended funds have a lot of liquidity, which means you can redeem your units whenever you choose. In comparison to other types of long-term investments, open-ended funds allow for redemption at the current Net Asset Value.
- Systematic Investment Form: Close-ended funds require investors to make a lump-sum investment to purchase the fund's units at the time of its debut. This can be a dangerous way to handle your investments. It allows you to place larger wagers than would otherwise be possible. Open-ended funds, on the other hand, are a good investment option for a lot of salaried individuals. It's because they can invest through SIPs.
Drawbacks Of Open-Ended Funds
- Asset Composition: Open-ended funds hire fund managers that are well-qualified and have previous expertise in the industry. They make all of the choices about the fund's securities selection. As a result, the investors have no input in the asset composition of the fund.
- Market Risk: Open-ended funds are vulnerable to market risk, even though the fund manager maintains a well-diversified portfolio. The fund's NAV fluctuates in response to the changes in the underlying benchmark.
What Are Close-Ended Funds?
Close-ended funds have a predetermined amount of fund units that can be engaged on share exchanges. Close-ended funds are more similar to an exchange-traded fund than a mutual fund. They are issued to raise money through a new fund offer and then traded on the open market, much like stocks.
Though the fund's value is determined by the NAV, the fund's actual price is determined by supply and demand, thus it can trade at prices above or below its true value. As a result, close-ended funds can trade at a premium or a discount to their net asset values. Brokers are used to buying and selling close-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.
Benefits of Close-Ended Funds
- Market Prices: Close-ended funds, like equity shares, are typically traded on stock exchanges. This allows investors to buy and sell fund units based on real-time values that may be higher or lower than the fund's NAV. They can also use standard stock trading tactics such as market and limit orders, as well as margin trading.
- Stable Asset Base: Close-ended funds have a stable asset base since investors can only redeem their units on predetermined dates. A steady asset basis makes it easier for the fund manager to create an investing plan. In the case of stable asset bases, fund managers can also keep the fund's overall objectives in mind without having to worry about inflows and outflows.
- Liquidity and Flexibility: Investors are entitled to liquidate close-ended funds by the fund's rules. Investors can buy and sell close-ended fund units at market prices using real-time pricing accessible during the trading day. This gives them the required freedom to make investment decisions based on real-time data.
Drawbacks of Close-Ended Funds
- Poor Performance: Over a variety of time horizons, close-ended funds have not performed as well as open-ended peers. The lock-in period on close-ended funds, which is supposed to give fund managers more flexibility in allocating funds without fear of outflows, hasn't helped much in terms of improving returns.
- Lump-Sum Investment: Close-ended funds require you to make a lump-sum investment at the time of their inception. This can be a dangerous way to handle your investments. It allows you to place larger wagers than would otherwise be possible. Furthermore, a considerable proportion of paid investors are unable to make lump-sum investments. Instead, they prefer methodical investment strategies with phased investments.
- Non-Availability Of Track Record: Because historical data is available for open-ended funds, investors can examine their performance over multiple market cycles. The track record of close-ended funds, on the other hand, is not available. As a result, investment in a close-ended fund has risks that you can only rely on the fund manager to mitigate.
Wrapping Up: Open-Ended Vs Close-Ended Funds
It is difficult to determine whether open-ended funds are superior to close-ended funds or whether close-ended funds are superior to open-ended funds. It makes no difference whether a fund is open-ended or close-ended; its performance is determined by the fund category, the fund management, and the investment strategy.
Some investors in open-ended funds are quick to redeem their units after the NAV has appreciated by between 5 and 10 percent to book profits in the short term. Those investors who maintain their holdings in the funds will suffer as a result of this. Because of the lock-in period, which prevents early redemption and safeguards the interests of long-term investors, close-ended funds are the superior choice in these kinds of circumstances.
Open-ended funds are a good option for investors who have limited or no knowledge of the financial markets but still want a return on their money that falls within the range of 12–15 percent on an annualised basis. The fact that these funds are managed by professionals and industry specialists, in addition to their highly liquid nature and daily NAV updates, provides investors with a marginally greater return than would be the case with close-ended funds.
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