India has seen a significant increase in mutual fund accounts and inflows into various mutual fund schemes as it has gained immense popularity across different strata of the society. This rise in popularity can be contributed to ‘Mutual Fund Sahi Hai’ campaign, increase in financial literacy, minimum investment requirement, rise in mobile internet connections, slick new-age mobile apps for investments, etc.

Investors have also realized that they can build long-term wealth through mutual funds which are professionally managed and offer them a lot of diversification opportunities.

This leads us to be aware of how mutual funds are broadly classified in terms of their structure and the main categories are open-ended and close-ended mutual fund schemes which we will be discussing in this blog.

Open-ended mutual funds

Open-ended mutual fund schemes offer investors a lot of flexibility and liquidity. This means that investors can purchase units of open-ended mutual fund schemes even after the new fund offer (NFO) ends.

Mutual fund schemes are introduced to the public for the first time through new fund offers and these NFOs have a start date and end date. Investors must apply to these NFOs to buy units of the mutual fund scheme for the first time.

As these MFs are open-ended, they do not have any fixed maturity dates and they have no lock-in period, except for ELSS mutual fund schemes which is for three years. But these schemes carry an exit load which the investors must pay if they redeem before specific number of days or months as mentioned in scheme information document (SID).

Investors can invest in these schemes through lumpsum or systematic investment plan. Systematic Investment Plan is more suited for investors with regular income and salary. It also helps the investor in rupee cost averaging and minimises the risk of market volatility.

To invest in these schemes, investors can buy units during the NFO period and also after the NFO period closes. These units have a price which is called the net asset value. So if you buy 700 units of a scheme at a net asset value of Rs 10, then your total net asset value is Rs 7000. These net asset value will fluctuate as the market fluctuates as the net asset value is based on the returns of the underlying securities of the scheme. This net asset value is updated daily at the end of the day.

If an existing investor or a new investor wants to buy new units of a scheme, the AMC will create new units and these units can be bought at the current net asset value and not at the value bought during the NFO.

These schemes are highly liquid because the units of the schemes can be bought and sold at any time and new units are added when fresh inflow come into the scheme. Both the buying and selling happens at the current net asst value of the scheme.

Close-ended mutual funds

Only a limited number of units are sold in these kind of MF schemes and the units can be bought only during the time of NFO and not after the NFO closes. They have fixed open and close dates and they raise a specific amount of capital during the NFO.

Close-ended mutual fund schemes are not flexible and liquid like open-ended mutual fund schemes. Since units can be bought only once, there is no SIP option in close-ended MF schemes. Investors can buy the units only through lumpsum.

Since the units can be sold and bought only during a specific duration, the unit capital of the scheme remains stable and does not fluctuate. But the outstanding net asset value will rise and fall based on the volatility of the underlying securities.

As the units cannot be redeemed whenever the investor wants, these schemes should be mandatorily listed on a recognized stock exchange to provide an exit route for investors before maturity. So after the NFO closes, the units must be traded on the secondary market.

Due to this trading in the secondary market, the market price of the units of close-ended fund will rise or fall depending on the demand and supply of the units. Therefore the NAV and the transaction price is always different.

These schemes are suitable for long-term and experienced investors and high net worth individuals (HNIs) who are willing to be invested for a longer time with higher capital.

Conclusion

Whether it is open-ended or close-ended mutual funds, investors must carefully select the scheme based on their financial situation and financial goals. They must also take into account other factors like the duration of investment as these schemes are likely to give good returns on the long-term due to the effect of compounding.

If an investor needs flexibility and high liquidity, then he or she must go for open-ended MF schemes. On the contrary, if the investor is not so particular about high liquidity and has enough money to do lumpsum investment and wants stability, then close-ended funds are a good option.

Frequently Asked Questions

1. What is the main difference between open-ended and close-ended mutual funds?

In Open-ended funds investors can buy or sell mutual fund units anytime at NAV, while close-ended funds can only be bought during the NFO and not after the NFO closes.

2. Can I invest via SIP in close-ended mutual funds?

Ans: No, SIP is only available in open-ended schemes. Close-ended funds accept one-time investments which is during the NFO period.

3. How is NAV calculated in open-ended funds?

The Net Asset Value (NAV) is calculated and published daily at the end of the day based on the performance of underlying securities of the scheme.

4. Why are close-ended funds listed on stock exchanges?

It is listed because close-ended funds are not liquid as open-ended MF schemes and to provide an exit route for investors before maturity.

5. Which mutual fund type is better for beginners?

Open-ended mutual fund schemes are a better option for beginners as these funds are flexible, have SIP options, and investors can easily buy and sell the units, making them ideal for most retail investors.