Mutual funds are classified according to various attributes, such as the nature of the Investment, Risk Profile, and Investment philosophy. Apart from these, the funds differentiated on the basis of their structure—Open-ended and Closed-ended. The difference between the two depends on the flexibility of sale and purchase of fund units.
Open-ended MF Schemes:
These funds buy and sell units on a continuous basis and, hence, allow investors to enter and exit as per their convenience. The units can be purchased and sold even after the initial offering (NFO) period (in case of new funds). The units are bought and sold at the Net Asset Value (NAV) declared by the fund.
The number of outstanding units goes up or down every time the fund house sells or repurchases the existing units. This is the reason that the unit capital of an open-ended mutual fund keeps varying. The fund expands in size when the fund house sells more units. Than it repurchases as more money is flowing in. On the other hand, the fund’s size reduces when the fund house repurchases more units than it sells. An open-ended fund not obliged to keep selling new units all the time. For instance, if the management thinks that it cannot manage a large-sized fund optimally; it can stop accepting new subscription requests from investors. However, it has to repurchase the units at all times.
Closed-ended MF Schemes:
The unit capital of closed-ended funds fixed and they sell a specific number of units. Unlike in open-ended funds, investors cannot buy the units of a closed-ended fund after its NFO period is over. This means that new investors cannot enter, nor can existing investors exit until the term of the scheme ends. However, to provide a platform for investors to exit before the term, the fund houses list their closed-ended schemes on a stock exchange.
Trading on a stock exchange enables investors to buy and sell units through a broker in the same manner as transacting the shares of a company. The units may trade at a premium or discount to the NAV depending on the investors’ expectations of the fund’s future performance and prospects. The demand and supply of fund units and other market factors also affect their price.
The number of outstanding units of a closed-ended fund does not change as a result of trading on the stock exchange. Apart from listing on an exchange, these funds sometimes offer to buy back the units, thus offering another avenue for liquidity. SEBI regulations ensure that closed-ended funds provide at least one of the two avenues to investors for entering or exiting.
