A mutual fund is launched through a New Fund Offer (NFO). If you apply during this period, you will get 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. This is typically 3-4 years from the launch date.
Open Ended Funds v/s Close-Ended Funds
While an open-ended fund allows investors to enter and exit the fund anytime after the NFO, 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 Investing In 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 over different market cycles is available. This allows investors in taking 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 a close-ended funds.
Disadvantages of Investing In Open-ended Funds
However, it must be noted that open-ended funds do carry some risks with them. Unlike, close-ended funds, open-ended funds are vulnerable to large inflows and outflows. A sudden outflow can force the fund manager to sell his stocks 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. Without lock-in, investors may be tempted by greed to invest more money in bull markets and by fear to redeem in volatile conditions.
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.
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.
Recently Launched Open-ended Funds
- Mahindra Rural Bharat and Consumption Yojana: Mahindra Mutual Fund initiated the new fund offer (NFO) for the Mahindra Rural Bharat and Consumption Yojana on October 19, 2018. The scheme is mandated to invest in companies that have exposure to India’s rural economy. The fund uses Nifty 200 Index as the benchmark.
- Baroda Dynamic Equity Fund: Baroda Pioneer Mutual Fund initiated the NFO of Baroda Dynamic Equity Fund October 22, 2018. This fund is structured to move into equity and debt as per market conditions while maintaining a 65% gross equity exposure for favourable tax treatment. The fund uses S&P BSE 200 Index (50%) and CRISIL Short Term Bond Fund Index (50%) as its benchmarks.
- Tata Small Cap Fund: Tata Mutual Fund initiated a new fund offer (NFO) of the Tata Small Cap Fund on October 19, 2018 with the mandate to invest in small cap companies. The fund uses Nifty Smallcap 100 TRI as its benchmark.
- UTI Floater Fund: UTI Mutual Fund initiated the NFO for UTI Floater Fund October 12, 2018. The fund uses CRISIL Ultra Short Term Debt Index as its benchmark. At least 65% of the scheme assets are invested in various floating rate instruments (instruments with interest rates tied to overall rates in the economy).
- L&T Focused Equity Fund: L&T Mutual Fund initiated the NFO for the L&T Focused Equity Fund on October 15, 2018. This fund is mandated to follow a focused approach, investing in a maximum of 30 companies. The fund uses Nifty 500 Total Return Index as its benchmark.
Tax Treatment of Open-ended Funds
The tax treatment of an open-ended fund will depend on whether it is an equity fund or a non-equity fund. You can read about taxation of equity mutual funds and non-equity mutual funds here.