Open Ended and Closed Ended Funds
DIFFERENCES BETWEEN OPEN-ENDED AND CLOSED-ENDED FUND OPEN END FUND DEFINATION A type of mutual fund that does not have restrictions on the amount of shares the fund will issue. If demand is high enough, the fund will continue to issue shares no matter how many investors there are. Open-end funds also buy back shares when investors wish to sell.
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CLOSED END FUND DEFINATION A type of fund with a fixed number of shares outstanding, and one which does not redeem shares the way a typical mutual fund does.
Closed-end funds behave more like stock than open-end funds: closed-end funds issue a fixed number of shares to the public in an initial public offering, after which time shares in the fund are bought and sold on a stock exchange, and they are not obligated to issue new shares or redeem outstanding shares as open-end funds are. The price of a share in a closed-end fund is determined entirely by market demand, so shares can either trade below their net asset value (“at a discount”) or above it (“at a premium”) also called closed-end investment company or publicly-traded fund.
The main differences between these funds are; Open-ended 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). Under closed-ended funds their unit capital is 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 till 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. The units of an open-ended fund are bought and sold at the net asset value (NAV) CEFs do not have to deal with the expense of creating and redeeming shares, they tend to keep less cash in their portfolio and they need not worry about market fluctuations to maintain their “performance record”.
Closed end fund prices are determined by supply and demand and not by asset value. Therefore the market price might be greater than or less than the share NPV. 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 regulations ensure that closed-ended funds provide at least one of the two avenues to investors for entering or exiting.
On the other hand the number of outstanding units in open-ended fund 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. The closed-ended funds are free from the worry of regular and sudden redemption and their fund managers are not worried about the fund size. However, open-ended fund have outperformed the closed-ended funds comprehensively.
In open-ended funds risk depends on the quality and the kind of portfolio you invest in. One unique risk to open funds is that they may be subject to inflows at one time or sudden redemptions, which leads to a spurt or a fall in the portfolio value, thus affecting your returns. Also, some funds invest in certain sectors or industries in which the value of the in the portfolio can fluctuate due to various market forces, thus affecting the returns of the fund. Investing in closed-end funds is more appropriate for seasoned investors.
Depending on their investment objective and underlying portfolio, closed-ended funds can be fairly volatile, and their value can fluctuate drastically. Shares can trade at a hefty discount and deprive you from realizing the true value of your shares. Since there is no liquidity, investors must buy a fund with a strong portfolio, when units are trading at a good discount, and the stock market is in position to rise. Open ended funds do not have the flexibility to borrow against their assets thus they cannot use leverage as part of their investment strategy.
Close end fund on the other hand have flexibility to borrow against their assets allowing them to use leverage as part of their investment strategy. Closed-end mutual funds continuously trade on the open stock market throughout the day. The prices of these funds are continually shifting to meet supply and demand. On the other hand, open-end mutual funds recalculate their share price once per day when the stock market closes and the value of its underlying stock assets are recalculated.
Therefore, investors can buy and sell their shares based on the price of the open-ended mutual fund at the close of the previous business day, when the NAV was recalculated. Closed-ended fund shares can be traded at any time during market opening hours. On the other hand open-end fund can usually be traded only at a time of day specified by the managers, and the dealing price will usually not be known in advance. REFERENCES. Russell Ray. An introduction to Mutual Funds worldwide. 2007 Tripathy P. Mutual Funds : Emerg