Mutual funds are one of the most popular investment products these days due to their ability to offer better returns when compared to conventional investment products such as bank deposits, gold, real estate, etc. They are professionally managed investment vehicles that pool the money of many investors and invest it in stocks of companies thereby generating capital appreciation for the investor.
Mutual funds are classified based on various attributes such as investment philosophy, nature of the investment, and risk profile. They can also be classified on the basis of their structures and when they are, they are of 2 types - open-ended and close-ended mutual funds. The differentiating factor between them is the flexibility they offer in terms of selling and buying of the fund units.
What is an open-ended mutual fund?
An open-ended mutual fund does not have any limitations of the number of shares it can issue. Purchase and sale of units in this kind of funds happens on a continuous basis thereby allowing investors to subscribe and redeem the units at their convenience. Open-ended mutual funds also allow the purchase and sale of units even after the closure of the NFO (New Fund Offer) period. The purchase and sale of units is done at the NAV (Net Asset Value) divulged by the fund.
Every time the AMC (asset management company) repurchases or sells the existing units of a fund, the number of outstanding units either increases or reduces and therefore, open-ended mutual funds see a variation in their unit capital. There is an expansion in size of the fund when more units are sold by the AMC than it repurchases because there is an increase in the flow in money. Similarly, if the AMC repurchases more units of the fund than it sells, there will be a reduction in the size of funds.
Open-ended mutual funds have no obligation to sell new units on a continuous basis but they do need to repurchase the units at all times. A majority of mutual funds are open-ended, offering investors a convenient way of investing.
How is it different from a close-ended mutual fund?
Close-ended mutual funds have a limit to the number of shares they can issue. Their unit capital is fixed and investors cannot purchase the units once the NFO period is over. It means that investors will not have the flexibility to enter or exit the scheme unless the scheme tenure ends. Fund houses, however, offer a platform to investors to exit the scheme before the end of the tenure by listing the close-ended fund on the stock exchange. There is no change in the number of outstanding units due to the trading of the fund on the stock exchange.
Sold mostly through brokers, close-ended funds are likely to trade at discounts to the value of their underlying asset. Investing in a close-ended fund can be a bit tricky as the track record of the fund is not available and it may carry uncertainties with it. Hence, it is recommended to invest in units of an open-ended fund instead.
Should you opt for an open-ended mutual fund?
Definitely. Open-ended mutual funds present an easy and cost-effective opportunity to grow your wealth. Over the same period, open-ended mutual funds have been known to deliver better returns in comparison to close-ended funds. The performance of the fund will however, vary based on the nature of investments, the category of the fund, and the investment strategy.
The advantages that an open-ended mutual fund offers have been explained below. Based on this, you can decide for yourself if you should invest in the units of an open-ended fund.
- Availability of track record - Open-ended mutual funds have a track record of their performance over the years and hence, you can make a well-informed decision whether or not to invest in them.
- Liquidity - As open-ended funds allow you to redeem the units according to your convenience, you can enjoy high liquidity. The redemptions will take place at prevailing NAVs of the units.
- Systematic Investment Plan - Unlike in a close-ended fund where you need to invest a lump sum amount, open-ended funds allow you to invest through the SIP (Systematic Investment Plan) route. SIPs allow you to invest a fixed sum every month thereby hedging the risk involved.