Based on the flexibility of investment and redemption, mutual funds are classified into two. These are open ended mutual funds and close ended Mutual Funds. Before a New Fund Offer (NFO), the Mutual Fund House (Asset Management Company) decides whether it wants the Mutual Fund Scheme to be open ended or close ended.
Open Ended Mutual Funds
In an open ended mutual Fund Scheme, an investor can enter or exit from the scheme at any time. There is no period for which the fund is open to subscription. The exit option means, you can sell your units at any point of time at the NAV per unit of that particular day. When you are selling the units, it is the Mutual Fund company that buys your units back from you. Similarly the Mutual Fund Company will also be selling more units to new subscribers. With each day, the net Assets Under Management (AUM) of the Fund keeps changing with these transactions.
Close Ended Mutual Funds
Close ended mutual funds are more rigid when compared to the Open Ended Funds. These funds are available to be be bought from the AMC only during the New Fund Offer period. This means that the number of units issued under the fund will be fixed once the fund offer period is over. The Close Ended Funds can thereafter be bought and sold on the secondary market. The AMC doesn’t involve itself in these operations. The Assets under management of the mutual fund company thus remains the same.
Which one is better?
- Close ended mutual funds require you to invest in lump sum. However, this might not be an active proposition to the majority of investors like the salaried class who would like to invest a tiny sum every month. Open ended funds provide this flexibility.
- Close ended funds also doesn’t provide you with the kind of liquidity that open ended funds provide. In case of an open ended fund, the AMC itself buys back your units and hence you can be assured to get the NAV of that particular day. This is not the case with Close ended fund, where your liquidity is subject to the whims and fancies of the market.
- Close ended funds provide the fund house with more certainty of the corpus under its management. The fund manager knows that the money will stay invested in the fund until maturity. This would enable him/her to execute the strategy more efficiently.
- In case of an open ended fund, you are able to track the past performance of the fund. Even though past performance of a mutual fund is no guarantee of future performance, it provides a baseline. However, in the case of a close ended fund, you have no data to base your decision other than the reputation of the fund manager.
- If the performance of past 5 years is any indication, open ended mutual funds have outperformed close ended fund peers.
For a beginner investor it would be more prudent to invest in an open ended mutual fund as it is more flexible and also has provided more returns in general. If you are a seasoned investor and knows about the fund managers performance in the past, only then can it be justified to invest in a close ended mutual fund.