Open-Ended And Closed-Ended Funds – Differences, Pros and Cons
Based on the investment structure, mutual funds in India are of two types: open ended and close ended funds. On the surface, open ended and close ended mutual funds may look similar. A closer look, however, would reveal some differences between these two types of mutual funds. Before investing, you might want to consider the differences as it is a function of investment flexibility and the ease at which you can buy or sell them.
What Is an Open Ended Fund?
Open end funds are one of the most common forms of investment in India that are always open to investments and redemptions. They are open perennially, meaning they do not come with a certain lock-in period. Therefore, investors can expect flexibility when buying or selling units of this fund.
In addition, this fund’s NAV (Net Asset Value) is evaluated on the underlying securities’ daily value at the end of the day. However, these funds are not traded on stock exchanges.
What Are Close Ended Funds?
In this type of mutual fund scheme, the investments come with a lock-in period. Investors can subscribe to these schemes only during the New Fund Offer (NFO) period and sell units only after the lock-in period or tenure of the scheme is over.
Nevertheless, some Asset Management Companies (AMCs) can transfer the proceedings from a close ended fund after its maturity to another open ended fund. However, they need an investor’s consent to do so.
While drawing differences between open ended and close ended funds, experts argue that the lock-in period concerning the latter ensures the stability of assets. This allows the fund manager to create a portfolio with long-term growth potential. However, in the case of open end funds, there is always a chance of cash outflows during the redemption of units.
Advantages of Open Ended Funds
1. Liquidity
As an investor of this type of fund, you can sell units of your investment any time you prefer. Hence, mutual funds without a certain lock-in period are known to offer more liquidity compared to funds with a lock-in period.
2. Availability of systematic options
By investing in these funds, individuals can avail several systematic plans for both withdrawal and investment purposes. Some of these systematic plans include the Systematic Withdrawal Plan (SWP), Systematic Investment Plan (SIP) and Systematic Transfer Plan (STP).
3. Track record and past performance
The track record of these funds’ performance across different markets is available to all investors. By going through this data, one can know about the past performance of a fund and make an informed decision.
Disadvantages of Open Ended Funds
1. Affected by market fluctuations
Although fund managers of open ended funds maintain a highly diversified portfolio, these are vulnerable to market risks. Hence, the NAV of such funds fluctuates subject to the movement of the underlying benchmark.
2. Vulnerable to large outflows and inflows
During sudden outflows, a fund manager may be compelled to sell his stocks. In such a case, it can cause a loss to all unitholders in the fund.
Advantages of Close Ended Funds
The close ended mutual funds has its advantages and are as follow:
1. Stability in the asset structure
As this type of fund allows investors to redeem units after the maturity period, it provides fund managers with a stable asset base that is not affected by frequent redemptions.
2. Trade on stock exchanges
Like any other equity fund, close ended funds are also traded on stock exchanges, that is, they can sell or buy units in real-time.
3. Flexibility and liquidity
Investors can easily liquidate these funds by selling them on the stock exchanges.
4. Low operating costs
As these funds come with lower turnover rates and marketing costs, their operating and management costs are also relatively low.
Thus, you can invest in a Navi Long Term Advantage ELSS (Equity Linked Savings Scheme) Fund Direct-Growth from Navi AMC and save taxes while aiming for long-term goals. Also, invest in a diversified portfolio with a lock-in period of just 3 years and obtain maximum returns from this fund.
Disadvantages of Close Ended Funds
Before comparing open ended and close ended funds, you may want to consider the limitations of close ended funds:
1. Non-availability of track records
Unlike open ended funds, you cannot check the performance of close ended schemes over different market cycles. Therefore, while choosing a fund, a manager’s expertise plays a major role.
2. You cannot invest through systematic plans
By investing in close ended funds, you only have the option of choosing a lump sum investment mode.
3. Poor performance
These funds are likely to perform poorly than their open ended counterparts historically.
Also Read: What are Fund of Funds: Top Funds, Types & Its Benefits
Differences Between Open Ended and Close Ended Mutual Funds
| Parameters | Open ended funds | Close ended funds |
| Maturity period | They do not have a maturity period. | They come with a maturity period ranging from 3 to 5 years. |
| Fund management | Fund managers have to mandatorily stick to the investment objectives. Also, there is pressure on them as investors can redeem units any time they prefer. | Fund managers have no additional pressure as the investors’ assets are under a lock-in period. |
| Listings | These schemes are not listed on the stock exchange. | These are listed on the stock exchange. |
| Fund size | Flexible. | Fixed. |
| Transaction time | At the end of the day. | Real-time. |
| Price determination | Shares sold at an NAV declared by the fund. | Share prices vary depending on demand and supply. |
Open Ended or Close Ended Mutual Funds: Which is the Better Pick?
| Features | Open ended funds | Close ended funds |
| Liquidity | High liquidity because you can buy or sell units any time you prefer. | No liquidity during the lock-in period. You can redeem units once the maturity period is over. |
| Track record | You can check the performance track record of these funds before investing. | No track record is available. |
| Investing mode | You can invest in a lump sum or Systematic Investment Plans (SIPs). | Investment is possible only during the New Fund Offer (NFO). |
| Investment amount | Individuals can start investing with low amounts such as Rs.500 or Rs.1000. | Rs.5000 is the minimum investment amount for investing in this fund. |
| Rupee cost averaging | Due to the SIP investment mode, you can take advantage of rupee cost averaging. | No averaging facility is available as post NFO period you cannot add investments. |
Taxation of Open Ended Funds and Close Ended Funds
Open ended and close ended mutual funds have similar tax treatment. Both these funds can invest in equity and debt instruments. In India, the taxation structure is different for equity and debt mutual funds and these funds are considered as equity-oriented funds or debt-oriented funds as per asset allocation. If at least 65% of the investment corpus is allocated to equity and equity-related instruments, these mutual funds are considered as equity mutual funds for taxation. Otherwise, the mutual fund schemes are considered as debt mutual funds for taxation purposes.
In case of equity funds, the gains are subject to STCG tax if the holding period is less than 12 months. The rate of taxation is 15%. In case the holding period is one year or more, the realized returns are subject to LTCG tax. The rate of taxation in the case of LTCG is 10%. Note that capital gains from these funds of up to Rs. 1,00,00 are exempt from LTCG tax.
Now, let’s look at the tax treatment of debt mutual funds. These funds are also subject to LTCG or STCG as per holding period. If the holding period of these periods is less than 3 years, the gains arising from these funds are taxable as per the respective tax slabs. On the other hand, if the holding period is 3 years or more, LTCG tax is applicable at the rate of 20% with indexation benefit.
Also Read: 10 Best-Performing Corporate Bonds In India (2022 Update)
Final Word
Looking back, one may conclude that open ended funds offer more flexibility than close ended ones. However, close ended mutual funds offer more leeway for the fund manager helping them maintain a portfolio that can make long-term gains.
Therefore, the decision of choosing between open ended and close ended funds is entirely up to you. For starters, you might want to refer to the aforementioned section to make an informed decision.
FAQs
Ans: No, ELSS funds come with a lock-in period of 3 years. Therefore, you can buy or sell units after the maturity period.
Ans: No, while investing in open-ended funds, investors might need to pay taxes on capital gains or incomes derived from such investments.
Ans: The NAV is evaluated by subtracting the fund’s liabilities from its assets.
Ans: The units of these funds are sold at the fund trading price during the daytime. These investments reflect on market values other than NAV.
Ans: In the case of closed-end funds, tax rates depend on the investment percentage made by the scheme in debt and equity. If 65% of the assets are invested in equity and equity-related instruments, it will be taxed like any other equity fund. Otherwise, it will be taxed just like a debt fund.
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
