Open Ended Mutual Funds vs. Closed Ended Mutual Funds
Mutual funds are professionally managed funds which invest the public money in the stocks and other instruments. These mutual funds are under great scrutiny as they are directly dealing with the public money.
There are many restrictions and condition on mutual fund to operate. These restrictions are imposed on the funds to ensure that the public money is not misused or mishandled.
On the basis of the structure of the mutual fund, it can be divided into open Ended and Closed Ended funds. The major difference on these types of funds is the flexibility in the sale and purchase of the fund units held by the investor.
Open Ended Mutual Fund
Open ended mutual funds are the normal funds available in the market. These funds start with the initial public offering in which the money inflows in these funds from the public but they can also sell the units initial public offering. The mutual fund works on the phenomenon that with increase in investment in the fund the number of shares also increases. When an investor invests in the mutual fund, more shares are created and when the investor takes out the money the shares are taken out of circulation. The mutual funds maintain some extra cash to ensure that they don’t have to sell their investment in stocks if the investors come asking for their money.
There is no trading of mutual fund units like the stocks. The mutual fund maintains a NAV at the end of each day at which the mutual fund units are bought and sold. Each fund unit has the value of Net Asset Value divided by the number of fund units.
Closed End Mutual Funds
Closed end mutual funds are more like exchange traded funds as in these funds they are launched with an IPO to raise money and then trade on the exchange like stocks. The Closed end mutual funds also maintain an NAV but the value of fund unit is derived from the demand and supply of the fund unit. With the better relative performance of the fund, the fund unit sells at premium. The funds only raise money once and also there is no option of redemption. The fund pays its investors by paying out the dividends.
Comparison between Open Ended and Close Ended
The major difference between the two is the flexibility in the sale and purchase of the fund unit. Since there is option for investor to take their money out of the open ended funds so these funds have to maintain higher amount of cash which remains unused and generate no return.
At the times of market behaving abruptly, closed end funds can use strategies to counter the losses in the later period as there is no option to take out the money but open ended funds take their money out and book losses prematurely. The close ended funds wait for the stock to return to intrinsic valuation and hence in many cases don’t even book losses.
The use of leverage is also allowed in the closed ended funds which further helps to boost the return on capital invested.
The open ended funds are a safer choice among the two because the money can be easily taken out of the fund while in the closed end there may be no demand of the fund unit and may not be able to take the money out of the mutual fund.
In general, Open ended funds represent a safer choice than closed ended funds, but the closed ended funds produce a better return.
About the Author:
The Author Ashish Khare is pursuing MBA in Finance from MDI Gurgaon. He takes keen interest in #financial markets having interned with RBI (Reserve Bank of India). Ashish recently qualified CFA Level 2 (Chartered Financial Analyst).