Open-ended and close-ended Mutual Funds
As promised earlier, in this chapter, we will categorize mutual funds based on maturity. Mutual funds are broadly categorized into two segments:
1. Open-ended mutual funds
2. Close-ended mutual funds
Open-ended mutual funds
As the name suggests, these funds are available for investment and redemption at all times. These kinds of mutual funds offer maximum liquidity and flexibility. They are the most common ones too. These funds neither have a maturity nor a lock-in period. They are open perennially. Purchase and redemption can be done at the prevailing NAV (explained in chapter 9). Since these funds remain open, investors can opt for lump-sum purchases or a systematic investment plan/SIP (explained in chapter 20).
These funds are highly liquid, providing an investor with the opportunity to make the most of their investment. Since it can be redeemed at any time, if a fund does not perform as per an investor’s expectations, he/she can always exit and invest the money somewhere else to earn better returns.
But herein lies a disadvantage of these funds. Due to frequent purchases and redemption, the AUM keeps changing which poses a challenge to the fund manager in implementing his financial strategy.
Close-ended mutual funds
These funds have a specific lock-in period during which neither purchase nor redemption is allowed. These funds open for a specific window of time for investment as a new fund offer (NFO). Then the fund closes down for a specific tenure. The money can be redeemed after this tenure gets over. Sometimes, even during the lock-in period, close-ended funds may open for a few days during which investors can purchase new units. Existing investors may also redeem and exit during these windows.
However, these kinds of liquidity windows are provided solely at the discretion of the fund manager, depending on the asset requirements of the fund.
In a close-ended fund, investors can redeem only at predefined dates. Hence, the fund manager has a stable AUM to work with and sudden redemptions do not affect his decision making. This helps the fund manager to execute his strategy more efficiently.
However, this may be a disadvantage for investors. Even if the fund performs poorly, they do not have the option to exit unless the liquidity window is offered. This can result in an opportunity loss and can be detrimental in the long run.
A close-ended mutual fund may be listed in a stock exchange where it can trade at a higher or a lower price than its prevailing NAV. This provides interested investors with an option to enter or exit even though the liquidity window is not open.
Open-ended vs Close-ended Mutual Funds