Open Ended Vs Close Ended Mutual Funds: Where Should You Invest?

What are mutual fund categories?

Neeraj Bora, Founder, Surmount Business Advisors Pvt Ltd, said, “Mutual funds are financial instruments that pool money from the investor to invest in a variety of securities, which include equity shares of listed companies, bonds and other money market instruments. Mutual funds are largely operated by fund managers or investment managers who can cater to millions of clients and who allocate funds to various investment options and are determined to produce income for the investors. There are many parties involved when setting up asset management companies, including fund sponsors, trustees, custodians, investment managers and registrars and transfer agents, and is governed by the Securities and Exchange Board of India.

He has explained below how open ended and closed ended funds differ from other mutual fund categories as well.

On the basis of asset class, investment-oriented and structure, there are different types of mutual funds available in the market. Based on the structure, there are mainly three types of funds, open-ended funds, closed-ended funds and interval funds.

open-ended funds An open-end fund is a type of mutual fund in which there is no limit on the transfer of shares. These are available for subscription throughout the year and do not have a fixed maturity date except for units of ELSS funds as they are locked in for 3 years from the date of investment. Shares are bought and sold on demand at their net asset value (NAV), which is based on the value of the underlying securities of the fund and is calculated at the end of the trading day. They are not traded on the stock exchange.

close-ended fund Closed-ended funds are fixed and they sell a specific number of units, under which investors cannot buy units after the NFO (New Fund Offer) is over and the lock-in period is over. If an investor wants to exit, he can do so only after the fund is listed on the stock exchange.

gap fund – The fund is a mix of both closed-ended and open-ended mutual funds, i.e. units can be bought or sold only during a specific interval. Unlike close ended where investors cannot buy or sell repeatedly.

Factors to consider before investing in open ended or closed ended funds

Sourav Basu, Head – Wealth Management, Tata Capital said, “Mutual funds are classified into two types on the basis of their structure as open-ended and close-ended mutual funds. Open-ended mutual fund schemes are regularly buy and sell units and allow investors to enter and exit the scheme at their convenience. Whereas close ended mutual fund schemes issue a fixed number of units which are sold and bought on the stock exchange. The subscription is done during the NFO (New Fund Offer) period only and the units can be redeemed after the lock-in period or at the end of the scheme tenure.”

“Some key differences between the two are the close-ended structure, which prevents investors from buying units after the NFO period is over; Whereas open ended schemes provide liquidity (can buy and sell units at any time except units of ELSS funds as they are lock-in for 3 years from the date of investment). In open ended, one can invest in lump sum and through SIP; Whereas in close ended one can invest only during the NFO period and cannot invest through SIP.”

“While close ended funds provide fund managers the flexibility to invest for longer durations without any redemption pressure, open ended mutual fund schemes provide investors with better liquidity, and flexibility to invest/redeem at any point of time. Also, an investor can invest through SIP to take advantage of rupee cost averaging or invest during market fluctuations. Also, in case of open ended funds, one can review the past track record and analyze the portfolio details of the schemes before investing,” said Sourav Basu.

Advantages and disadvantages of open ended and close ended funds

CA Manish P. Hinger, CEO and Founder, Fintu, said, “The major difference between open ended mutual funds and closed ended mutual funds is that open ended mutual funds provide high liquidity which means you can redeem your investments anytime. Close-ended mutual funds on the other hand come with a specified lock-in period. Although closed-ended funds can be traded on a stock exchange, the volumes will be very low. For most investors, given regular cash flows While it is more convenient to invest in mutual funds through SIP, such investors should opt for open ended mutual funds only as closed ended mutual funds do not offer SIP option.Also, to avail the benefit of rupee cost averaging SIP option is recommended in volatile markets. In close ended schemes, lumpsum investment has to be made during NFO.

“Additionally, opting to invest only in close ended schemes at the time of NFO has the disadvantage of having no track record of past performance. You also have to wait for the NFO to open for subscription to investment, whereas you can invest in open ended schemes anytime without waiting for the investment opportunity. Hence it is advisable to go for open ended mutual funds as there will be ample choice of different types of funds that you can choose from based on your ideal asset allocation without any of the drawbacks that come with closed ended funds.

What should be your objective while choosing an open ended or closed ended fund?

Utkarsh Sinha Managing Director Bexley Advisors a boutique investment bank firm, said, “As the name suggests, close-ended funds are closed for redemption till maturity. While it offers some taxation benefits, it provides some liquidity benefits. It is also easily tradable on any of the exchanges. Open ended funds have minimal withdrawal restrictions. As with any investment, the right choice is very individual and depends on one’s needs and objectives. Funds can offer greater stability for those committed to a longer term, as fund managers have more flexibility in their investment decisions, without the fear of redemption.Open-ended funds are better for those who need it Withdrawal potential is willing to offset that uncertainty. However, regardless of the nature of the fund, a common mistake most retail investors make is to buy high and sell at low price. Open-ended funds put you at greater risk of this. When you can sell in panic or buy in excitement.”

How do open ended or close ended funds work?

Kanika Agarwal, Co-Founder, Upside AI, said, “The main difference between the two is your ability to invest/withdraw money from the scheme. Open ended schemes allow you to invest and redeem at any point of time, whereas closed ended schemes have specific windows to invest and withdraw money from the fund. The tax treatment of both is the same. Equity oriented mutual funds are generally open ended. Equity oriented mutual funds are treated like shares for capital gains purposes, where they are taxed at 15% if held for less than 1 year and 10% for more than one year. If a scheme is not “equity oriented”, its capital gains are taxed as per normal income tax provisions.”

“A major difference between the two types is how the liquidity is created. Suppose you want to redeem an open ended fund, you would go to the respective MF house and the asset management company itself would buy the units at the current NAV. Secondly On the other hand, because close ended funds have a restricted investment/redemption window, they are traded on a stock exchange so that you can sell the units (like you would a stock). Often, the liquidity for these units may be low and therefore may so that you do not get NAV on exit. Also, SIP or regular investment is possible only in open-ended funds. Generally, closed-ended funds are set up keeping a certain strategy in mind – be it for a fixed period Whether investing in debt securities of the U.S. or private securities that are less liquid. Therefore, investors generally prefer open-ended schemes for their flexibility and liquidity. You should consider a closed-ended scheme when its strategy is unique. / be different, which you are unable to access in an open-ended manner,” he added.

Where should you invest?

Praneet Battina, Investment Team, Fi Money said, “Open-ended mutual funds are always open for investment and redemption as the fund house can issue and redeem units at any time without any lock-in or maturity period. On the other hand Close-ended funds do not allow fresh investments after the New Fund Offer (NFO). One of the major differences between the two is the liquidity. Open-ended funds are more popular among investors and are highly liquid. Close-ended funds units can be redeemed only on maturity, making them difficult to exit. This happens even when the units are listed on an exchange as the secondary market for these instruments is superficial.”

“For most investors, investing in open-ended funds is easier and represents a safer option because they are broader and more well-defined products. Closed-ended funds can be beneficial if your investment goals are within the maturity period.” and are aligned with the fund’s investment objectives, though they do not have a good track record. Fixed Maturity Plans (FMPs) that invest in equities come with the risk of adverse market conditions around the target date. Close-ended debt Funds face similar issues. The Essel Group default is a good case in point where several FMPs were unable to honor their maturity dates,” said Praneet Battina.

Disclaimer: The views and recommendations given above are those of individual analysts or broking companies and not of Mint.