Open ended vs close ended mutual funds: Where you should invest?

What are the mutual fund categories?

Niraj Bora, Founder of Surmount Business Advisors Pvt Ltd said “Mutual funds are financial instruments that pool money from the Investor to invest the money in different types of securities including equity shares of the listed companies, bonds, and other money market instruments. Mutual Funds are operated by fund managers or Investment managers on large -scale basis who can cater to millions of customers and who allocate the funds to different investment options and are determined to produce income for the Investors. There are lots of Parties involved while setting up Assets Management companies, including, Fund sponsors, Trustees, Custodians, Investment Managers, and Registrar and Transfer agents and is governed by the Securities and Exchange Board of India.”

He has explained below how other mutual fund categories as well as open ended and close ended fund differs.

Based on Assets class, Investment-oriented, and Structure, there are different types of Mutual funds available in the market. On the basis of structure, there are mainly three types of funds, Open-ended Funds, Close-ended Funds, and Interval funds.

Open-Ended Funds – An open-end fund is a type of mutual fund that does not have limits on the transfer of shares. These are available throughout the year for a subscription and do not have a fixed maturity date excepting the 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 fund’s underlying securities and is calculated at the end of the trading day. These are not traded on the stock exchange.

Close-Ended Funds – The closed-ended funds are fixed and they sell a specific number of units, under this investor cannot buy units once the NFO (New Fund Offer) is over and have a lock-in period. If any investor wishes to exit, they can do only once the funds get listed on the stock exchange.

Interval Fund – The fund is a mix of both close-ended and open-ended mutual funds, i.e., the units can be purchased or sold only during a specific interval. Unlike close ended where investors cannot purchase or sell frequently.

Factors to consider before investing a open ended or close ended fund

Saurav Basu, Head – Wealth Management, Tata Capital said “Mutual funds are categorised into two types as open-ended and closed-ended mutual funds based on their structure. Open-ended mutual fund schemes buy and sell units on a regular basis and allow investors to enter and exit the scheme at their own convenience. While close ended mutual fund schemes issues a fixed number of units that are sold and bought on the stock exchange. It is subscribed only during the NFO (New Fund Offer) period and the units can be redeemed after the lock-in period or the tenure of the scheme is over.”

“Some of the important differences between the two are in the close ended structure, which prohibits the investors to buy the units after the NFO period is over; while open ended schemes offer liquidity (can buy and sell units at any time except the units of ELSS funds as they are locked-in for 3 years from the date of investment). In open ended, one can invest via lumpsum as well as SIP; while in close ended one can invest only during the NFO period and cannot invest through SIPs,” he said.

“While close ended funds provide fund managers with the flexibility to invest for long term without redemption pressures but open ended mutual fund schemes provide investors – better liquidity, and flexibility to invest/redeem anytime. Moreover, an investor can invest through SIP to take advantage of rupee cost averaging or investing during market volatility. Also, incase of open ended funds, one can review the past track record and analyse the portfolio details of the schemes before investing,” said Saurav Basu.

Pros and cons of open ended and close ended funds

CA Manish P. Hingar – CEO & Founder at Fintoo said “The major difference between open ended mutual funds and close ended mutual funds is that open ended mutual fund offers higher 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 close ended funds can be traded on stock exchange, the volume will be too low. For most of the investors, investing in mutual funds by way of SIPs is more convenient looking at the regular cash inflows, such investors should opt for open ended mutual funds only as close ended mutual funds do not offer SIP option. Also, SIP option is recommended in volatile markets to take advantage of rupee cost averaging. In close ended schemes, one will have to invest lumpsum at one go during NFO.”

“Additionally, option of investing in close ended scheme only at the time of NFO has a disadvantage of not having any track record of past performance. You will also have to wait for an NFO to open for subscription to invest whereas you can invest in open ended scheme anytime without having to wait for an investment opportunity. It is thus suggested to opt for open ended mutual funds as it will have ample options of different types of funds which you can select based on your ideal asset allocation without any drawbacks that comes with close ended funds,” he said.

What should be your objective while opting for open ended or close ended funds?

Utkarsh Sinha managing director Bexley advisors a boutique investment bank firm said “As the name implies, close ended funds are closed to redemption till the maturity period. While this provides certain taxation advantages, it also is easily tradable on exchanges providing some liquidity benefits as well. Open ended funds have minimum restrictions on withdrawals. As with any investment, the right choice is a very personal one and a function of one’s needs and objectives. Closed funds may offer more stability for those committed to the longer term, as without the fear of redemptions, fund managers have greater flexibility in their investment decisions. Open ended funds are better for those who are willing to offset that uncertainty for the ability to withdraw when they need. However; irrespective of the nature of the fund, a common mistake most retail investors make is of buying high and selling low. Open ended funds put you at greater risk of this when you could sell in a panic or buy into a euphoria.”

How open ended or close ended funds work?

Kanika Agarrwal, Co-founder, Upside AI said “The main difference between the two is your ability to invest/ withdraw funds from the scheme. An open ended scheme allows you to invest and redeem anytime while a close-ended scheme has specific windows to invest and withdraw money from the fund. Both have similar tax treatment. Usually, equity oriented MFs are open ended. Equity oriented MFs are treated like stocks for capital gains purposes where if they are held less than 1 year, they are taxed at 15% and over a year at 10%. If a scheme is not “equity oriented” its capital gains are taxed as per normal income tax provisions.”

“A big difference between the two types is how liquidity is created. Say you want to redeem an open ended fund, you will go to the respective MF house and the asset management company itself will buy the units at the existing NAV. On the other hand, because close ended funds have restricted investment/ redemption windows, they are traded on the stock exchange so you can sell the units (like you would stocks). Often, liquidity for these units can be low and therefore you may not get the NAV at exit. Also, SIPs or regular investments are only possible in open ended funds. Usually, a close-ended fund is setup with a certain strategy in mind – be it investing in fixed duration debt securities or in private securities which are less liquid. Therefore, usually investors prefer open ended schemes for their flexibility and liquidity. You should consider a close-ended scheme when its strategy is unique/ differentiated which you are unable to access in an open-ended way,” she further added.

Where you should invest?

Praneet Battina, Investment Team, Fi Money said “Open-ended mutual funds are always open to investments and redemptions since the fund house can issue and redeem units at any given time without a lock-in or maturity period. Close-ended funds, on the other hand, do not allow new investments after the New Fund Offer (NFO). One of the key differences between the two is liquidity. Open-ended funds are more popular with investors and are highly liquid. Units of a close-ended fund can only be redeemed at maturity, making them difficult to exit. This is the case even if the units are listed on an exchange since the secondary market for these instruments is shallow.”

“For the majority of investors, open-ended funds are easier to invest in and represent a safer option as they are broader and more well-defined products. Close-ended funds can be beneficial if your investment goals align with the maturity period and investment objectives of the fund, although they do not have a good track record. Fixed Maturity Plans (FMPs) that invest in equity come with the risk of adverse market conditions surrounding the target date. Close-ended debt funds face similar issues. The Essel group default is a good case in point where multiple FMPs were unable to honour their maturity dates,” said Praneet Battina.

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