Understanding Open Ended Funds

The mutual fund industry is growing like never before owing to its promise of high flexibility, well-diversity, and expert portfolio management. There exist various types of mutual funds which investors can choose from according to their risk, return, time horizon, and liquidity preferences. They are mainly categorized based on asset classes, risk preference, investment goals, and structure. Based on structure, mutual funds are classified as open-end funds and closed-end funds.

This article spotlights what is an open-end fund, how it works, and its benefits.

Open-End Fund

An open-end fund is a type of mutual fund that pools money from various investors and invests it across various securities. In an open-end fund, investors purchase the units directly from the fund itself, at the prevailing Net Asset Value. Contrary to closed-end funds, open-end funds do not restrict the number of units issued; they can buy and sell units anytime. Additionally, these funds do not have a fixed maturity period.

Investors can invest directly into the open-end fund with the asset management company or via a distributor or broker. However, investing via the Association of Mutual Funds in India (AMFI) registered distributor or broker includes commission charges to the distributor. Direct investment excludes commission payment and thereby increases the return on investment. Investing in an open-ended fund by visiting a mutual fund branch or through their websites is a favourable option too.

There exist various Open-end funds that differ from each other by securities invested, investment strategy distribution policy, risk structure, etc. For taxation purposes, the open-end fund can be categorized as equity or debt funds, based on the weightage of asset investment in the portfolio. If the fund constitutes 65% or more of equity investment, the fund is treated as an equity fund from a tax perspective. On the contrary, if the fund invests 65% or more in debt securities, the fund is treated as a debt fund.

In an open-end fund, the number of outstanding units is dynamic and capitalization is not limited. Therefore, the fund manager cannot devise a stable strategy as the fund does not have a fixed-asset base.

There are a few key differences between closed-end funds and open-end funds. Unlike open-end funds, closed-end funds have lock-in periods. Therefore, the fund managers of closed-end funds can devise a stable investment strategy till maturity. However, open-end funds are liquid, and closed-end funds are relatively less liquid. An investor can track the performance of a closed-end fund overall. However, they may not have an idea of how a closed-end fund performed during different phases of the market cycle, which is possible with open-end funds.

Some of the examples of open-end funds in India include SBI Small Cap Fund, SBI Magnum Gilt Fund, Mirae Asset Emerging Bluechip Fund, Reliance Gilt Securities Fund Institutional, Aditya Birla Sun Life Banking & Financial Services Fund, and so on.

How do open-ended mutual funds work?

An open-ended fund is open for subscription for investors through a New Fund Offer. New Fund Offer is for funds, similar to IPO for stocks. This is a way for investors to subscribe to mutual fund units where the NFO subscription period remains open for 30 days usually. However, investors can also purchase the units of open-ended mutual funds after NFO closure. They can invest and withdraw a specific amount at regular intervals, via a Systematic Investment Plan (SIP) and Systematic Withdrawal Plan (SWP), in an open-ended fund.

Investors can trade the units of a fund at its Net Asset Value (NAV) which is determined by the number of units and the total value of underlying assets. It keeps fluctuating based on the market prices of stocks, bonds, and other securities of the respective fund.

Moreover, an open-end fund can issue additional units. Unlike closed-ended funds, open-ended funds do not trade on the stock exchange. However, if the mutual fund is open-ended, investors can redeem the units to fund houses at the existing NAV anytime.

Advantages of investing in an open-ended fund

• Well-diversified Portfolio: Open-end funds prevent investors from putting all their money in a single security or stock. A key benefit of a well-diversified portfolio is that even if one security performs poorly, the investor’s portfolio would be less impacted due to other well-performing securities.
• High Liquidity: Open-end mutual funds do not have a lock-in period. Investors can redeem the units of funds anytime. This brings an element of liquidity to an investor’s portfolio. Additionally, investors can redeem the units as per NAV at the moment. When the market is up, investors can gain the most out of their funds.
• Availability of Performance Data: Usually, investors make investment decisions by looking at the past performance of the funds in different market cycle phases. For open-ended funds, investors can track and compare the performance of a scheme during various phases of the market cycle. Therefore, investors can get a clearer picture of how their investment performed or can perform throughout the market cycle. This is not possible in the case of closed-end funds.
• Availability of SIP and SWP Options: Some investors do not have large disposable income to make a lump sum investment. However, open-end funds allow the investors to invest a fixed amount at regular intervals via a Systematic Investment Plan (SIP). Investors can also choose to withdraw a fixed sum at regular intervals from an open-end mutual fund.
• Professional Management: Open-end funds are managed by professional fund managers. As they have skills, knowledge, and experience in the market, they can make sound investment decisions. A wise investment decision ultimately drives hefty returns for investors.

To conclude, an open-end fund is a mutual fund which is open for subscription and can be exited anytime. One of the major benefits of such funds is the component of liquidity. Moreover, open-ended funds are managed by a qualified professional fund manager. Therefore, even novice investors can consider this as an investment option. However, the returns from investment, in the case of open-ended funds, depend highly on the fund manager’s judgment and decision-making skills.