Open Ended vs Closed Ended Mutual Funds
Open Ended Mutual Funds: In an open ended mutual fund, the units can easily be created and destroyed as and when a new investor decides to invest in the fund or redeem his money. Because of this liquid nature, the Mutual Fund unit is always priced at it’s NAV value. New units can be added or destroyed as and when the Fund Manager wishes.
Closed Ended Mutual Funds: In a closed ended scheme, the only time new shares
are created is during the NFO. Once the fund is listed on the exchange, it is traded just like any other stock. If you want to invest in the fund, you will have to purchase units from people who own them. The AMC cannot issue new units to you. There are two ways you can exit a scheme like this. The AMC will have periodic redemption offers where it will offer to buy your fund unit at its NAV and destroy it. You can also sell your units to another investor who might be interested in purchasing them.The price at which the units are traded are governed by the laws of demand and supply.
are created is during the NFO. Once the fund is listed on the exchange, it is traded just like any other stock. If you want to invest in the fund, you will have to purchase units from people who own them. The AMC cannot issue new units to you. There are two ways you can exit a scheme like this. The AMC will have periodic redemption offers where it will offer to buy your fund unit at its NAV and destroy it. You can also sell your units to another investor who might be interested in purchasing them.The price at which the units are traded are governed by the laws of demand and supply.
Which type of Mutual Fund is better?
In any Closed Ended Scheme, the fund manager does not have to worry about capital rushing in or out. Notice how difficult it must be for an Open Ended Mutual Fund’s Manager to allocate capital in an inflated bull market. Suppose you are the fund manager and you are in the middle of a stock market bubble and you have run out of sensible options to invest your money in because all assets are now being sold at an inflated price. Yet, enchanted by the bull market, new investors are pouring in with their capital and you have to invest it somewhere. You will be forced to invest the new money in an inflated asset. Similarly, in a bear market where you realize a lot of potential to buy under-priced stocks, you will find investors wanting to redeem money. Therefore, you will be forced to sell your fund’s holdings at discounted prices to pay off the investors instead of cashing in on golden opportunity to buy stocks at throwaway prices.
These problems don’t trouble a closed ended scheme’s manager because he does not have to worry about changes in the corpus. His capital is more or less fixed.
Historical data from Indian Markets suggest that Open Ended Schemes have outperformed Closed Ended ones. Essentially, the Closed Ended Schemes launched after 2006 were a reaction to the SEBI ruling that entry loads could not be charged on Open Ended Schemes. However, the AMC could still charge as much as 6% of the investment as Issuing Expense at one go for a closed ended scheme. Therefore, if you invested 100 Rupees, you actually got returns only out of 94 rupees. There were too many liquidity windows that defeated the purpose of a closed ended scheme. This is another example that demonstrates how sensible sounding theories may not work in the real world and why caution has to be always exercised while investing.
