If you have been noticing the recent inclination of average Indian investors towards mutual funds, you might be wondering the reason behind it. It is because of the high returns and tax saving benefits that these mutual funds offer relative to the traditional investments like real estate, precious metals, fixed and recurring deposits, etc. Since there is a high demand in the market for mutual funds, many new Asset Management Companies (AMCs) have been growing in India. We currently have more than 40 AMCs and mutual fund houses, offering many different types of mutual funds, categorized on the basis of volatility, risk, locking period, involved instruments, etc. Considering each fund house to host around 30 funds at an average, we have more than 1200 mutual funds in India.
Such huge number of funds with varying profiles makes it difficult for people to choose where to invest. It is advisable to get an in-depth detail of about all the different types of funds before you begin investing. In this article, we'll get an overview of two different types of Mutual Funds - Open Ended and Closed Ended Funds.
What are Open Ended Funds?
Mutual Funds having no fixed number of units are termed as open ended funds. By no fixed number, we mean that the fund house creates and destroys units as per their requirements. When the fund houses want more capital for investing or to pay their investors who are selling their units, they create new units for the fund and sell them in the market. When they feel that the number of units has grown to an amount which they cannot manage efficiently, they destroy some units by buying it back from the investors.
Unlike closed ended funds, the units of open ended funds can be purchased and sold at anytime the fund house or the investor wants. The trade of units takes place at the Net Asset Value (NAV) of the units, which is calculated at the end of each day by the host fund house. NAV depends upon the number of units of fund currently in circulation, value of the underlying securities, previous day selling and buying rates, etc.
What are Closed Ended Funds?
Mutual Funds falling under this category have a fixed number of units declared by their fund house. The investors can purchase and sell the units only during the New Fund Offer (NFO)
period, when the fund is being launched. These funds generally have a lock in period for which the investors have to hold the funds. In order to make these funds more liquid, the fund houses list these funds in the stock market, where the units can be purchased and sold in a way similar to the stocks of companies.
These funds are traded at a value different from their NAV, because after being listed on the stock exchange, a lot of factors like real time sell and buy orders, investors opinion about the firm, etc. If they are high in demand, they can be bought at a premium over their NAV value, and if they're not so liked, they are traded at discount prices. All these trades take place with the help of a broker.
Is there any fee associated with these funds?
Unlike mutual funds in the United States, there is no trading fee levied by the fund houses on the trading of fund units. However, your broker may charge a small percentage for making the transactions.
Which funds are better?
There is no good or bad fund. Generally, open ended funds offer much higher liquidity and low volatility than the closed ended funds. They also have the options like SIPs and SWPs, if you plan to invest in your portfolio on a regular basis. However, some closed ended funds maybe better than open ended funds too. So you should research about the fund thoroughly and consider it's liquidity, risk, returns, market opinion, underlying instruments, tax benefits, etc before making an investment.