Every mutual fund is launched through a New Fund Offer (NFO). When an investor applies for a mutual fund scheme during this period, he/she gets fund units at the NFO price (such as Rs. 10 or Rs. 100). An open ended fund is a fund which is officially launched after the NFO ends. It allows investors to enter and exit the fund anytime after they are launched. Whereas, a close-ended fund is a fund which does not allow entry and exit of investors after the NFO period, until maturity. Close-ended funds typically mature in 3-4 years from their launch date.
Open Ended Funds v/s Close-Ended Funds
An open-ended fund allows investors to enter and exit the fund anytime after the NFO, whereas a close-ended fund restricts the entry and exit of investors to the NFO period. Moreover, unlike close-ended funds, open-ended funds do not have a limitation on the number of units they can issue. More units of an open-ended fund get created when an investor invests his/her money in the fund. Similarly, when an investor redeems his/her units of an open-ended fund, the mutual fund units are taken out of circulation.
While open-ended funds allow investors to make use of systematic plans – systematic investment plans (SIPs), systematic withdrawal plans (SWPs) and systematic transfer plans (STPs), close-ended funds do not support this facility.
Advantages of Open-Ended Funds
- Liquidity: Open-ended funds provide high liquidity as they allow investors to redeem the fund units at any time they want. The fund units are redeemed at the fund’s net asset value (NAV) of the day on which units are redeemed.
- Availability of track record: Unlike close-ended funds, the performance track record of an open-ended fund spanning across different market cycles is available. This allows investors to take a well-informed decision.
- Systematic plans: Open-ended funds allow investors to make use of systematic plans both for the investment and withdrawal purposes. An investor cannot make use of SIPs, SWPs and STPs with close-ended funds.
Disadvantages of Investing In Open-ended Funds
Open-ended funds feature a number of advantages, however, they do carry some risks with them too.
- Firstly, unlike close-ended funds, open-ended funds are vulnerable to large inflows and outflows. A sudden outflow can force a mutual fund manager to sell holdings at rock-bottom prices, causing a loss to all unit holders in the fund.
- Moreover, open-ended funds also carry a significant amount of market risk. The NAV of an open-ended fund fluctuates every day owing to stock market volatility. Thus, one must cautiously invest in open-ended funds.
- The liquidity offered by open-ended funds can also be a disadvantage. Since there is no lock-in in case of open-ended funds, investors may be tempted by greed to invest more money in bull markets and by may redeem units in volatile conditions owing to fear.
- Open-ended funds also have exit loads. These are charges levied upon you if you exit the fund within certain predefined time periods, typically up to 1 year. Thus, the ultimate earnings from an open-ended fund gets reduced if it attracts capital gains tax.
Who Should Invest in Open-ended Funds?
Open-ended funds are suitable for investors who wish to invest in a liquid investment instrument and are willing to undertake market risk and cash flow risk for high returns.