Open-ended vs. closed-ended funds: What they are and how to choose

Posted On: 27 August 2024

Investing in mutual funds can be a convenient and popular way to grow your money, but it can also be a bit confusing, especially if you are new on this journey. When looking to select a mutual fund, among the various options out there, you will have to choose between open-ended vs. closed-ended funds. To learn which of these two options is suited to your investment needs and goals, it is first essential to understand both these categories, their key differences, and, most importantly, how to decide which one might be right for you.

Table of contents

What are open-ended funds?
What are closed-ended funds?
Key differences: Open-ended funds vs. closed-ended funds
Open-ended or closed-ended funds: Which one should you choose?

What are open-ended funds?

Open-ended mutual funds are investment funds that allow you to buy and sell units at any time. The key feature of these funds is that they don’t have a fixed maturity date. You can invest in them as long as the fund is open for subscription, and you can redeem your investment whenever you need your money back. The price at which you buy or sell units is based on the fund's Net Asset Value (NAV), which is calculated daily. Because of their flexibility, open-ended funds are a popular choice among investors. These funds typically offer diversification across a range of assets, which helps to mitigate risk.

Another advantage of open-ended funds is their liquidity; investors can easily convert their units into cash whenever there is a need. Additionally, open-ended funds are of various investment types, such as equity funds, bond funds, and hybrid funds, catering to different risk appetites and investment goals. These funds are managed by professional fund managers who use their expertise and judgement to create optimal outcome for investors. Due to their flexibility, professional management, and potential for diversification, open-ended funds are considered a suitable option for both new and experienced investors looking to build a balanced portfolio.

What are closed-ended funds?

Closed-ended mutual funds are a bit different in nature. As the name suggests, these funds have a fixed maturity period, usually ranging from three to seven years. When a closed-ended fund is launched, it raises a fixed amount of capital by selling a specific number of units. After the initial offering period, you cannot buy or sell units directly from the fund. Instead, these units are traded on the stock exchange, similar to stocks. The price of the units can vary from the NAV based on market demand and supply.

Closed-ended funds offer several unique advantages. Because the capital is fixed, fund managers can invest in less liquid assets without worrying about the pressures of sudden redemption. This structure allows for potentially higher returns, as managers can take a longer-term view on their investments. Additionally, closed-ended funds can trade at prices above or below their NAV, allowing investors to potentially buy units for less than the fund's actual value. These funds also provide access to a broader range of investment opportunities, including niche markets and specialised sectors, which might not be available in open-ended funds. However, the trading on the stock exchange introduces market risk and can lead to price volatility based on investor sentiment.

Key differences: Open-ended funds vs. closed-ended funds

Understanding the differences between open-ended and closed-ended funds can help you make an informed decision. The following are some significant factors to consider:

Factor	Open-ended funds	Closed-ended funds
Liquidity	You can buy and sell units anytime.	You can only trade units on the stock exchange after the initial offer period.
Maturity	No fixed maturity date.	Have a fixed maturity date.
Pricing	Units are priced based on daily NAV.	Units are traded on the stock exchange and can be priced above or below NAV.
Investment flexibility	High flexibility, suitable for investors needing access to their money.	Less flexible, more suitable for long-term investments.
Capital raising	Can continuously raise capital.	Raise a fixed amount of capital at launch.
Tax implications	Taxation is determined by the holding period, with short-term capital gains subject to a higher tax rate compared to long-term capital gains.	Similar tax treatment to open-ended funds but consider potential tax events due to trading on the stock exchange.
Investment amount	Allow for both lumpsum and systematic investment plans (SIPs), making it easy to start with a small amount and invest regularly.	Typically require a lumpsum investment during the initial offer period, which might be higher.
Rupee cost averaging	SIPs facilitate rupee cost averaging, helping to spread out investment costs over time and reduce market volatility risks.	Do not offer the SIP option, making it harder for investors to benefit from rupee cost averaging.

Open-ended or closed-ended funds: Which one should you choose?

Choosing between open-ended and closed-ended funds depends on your investment needs and goals. The following are some factors to consider:

Investment horizon: If you need flexibility and might want to access your money at any time, open-ended funds can be a suitable option. However, if you can afford to lock in your investment for a longer period, closed-ended funds might offer potentially better returns.
Liquidity needs: For those who need easy access to their money, open-ended funds provide potentially better liquidity. Closed-ended funds are less liquid but can offer potentially higher returns due to the fixed investment period.
Risk appetite: Open-ended funds are generally less risky because they are more flexible. Closed-ended funds might be riskier due to market price fluctuations but can also offer higher rewards.
Market conditions: In volatile markets, open-ended funds provide a relatively stable option as you can exit anytime. In stable markets, closed-ended funds might perform well and provide better returns.
Income requirements: If you require regular income from your investments, consider that open-ended funds might offer systematic withdrawal plans, while closed-ended funds often distribute earnings at predetermined intervals in the form of Income Distribution Cum Capital Withdrawal (IDCW), which might be less frequent.
Management style: Open-ended funds often have an active management style, with fund managers making frequent adjustments to the portfolio. This can be an advantage in terms of responding to market changes and opportunities. Closed-ended funds, on the other hand, allow fund managers to focus on long-term strategies without the pressure of daily redemptions, potentially leading to more stable performance over time.

Conclusion

Choosing between open-ended and closed-ended funds depends on your financial goals, risk tolerance, and need for liquidity. Open-ended funds offer flexibility and can be a suitable option for those who want easy access to their investments. Closed-ended funds, while less flexible, can provide potentially higher returns if you can commit to a longer investment period. Once you understand the key differences between open-ended and closed-ended mutual funds, you will be able to pick the one that aligns with your investment strategy.

FAQs

What are the different types of closed-ended mutual funds?

Closed-ended mutual funds include diversified equity funds, sector-specific funds, fixed maturity plans.

Can open-ended funds be redeemed?

Yes, open-ended funds can be redeemed anytime based on the current NAV.

Which funds are open-ended?

Most mutual funds, including equity, debt, and hybrid funds, are open-ended.

What is the meaning of ‘load’ in a mutual fund?

The term 'load' refers to the fee charged when you sell (‘exit load’) mutual fund units.

Is SIP open-ended?

Yes, a Systematic Investment Plan (SIP) is typically open-ended, allowing regular investments in mutual funds with the flexibility to redeem anytime.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.