Open-end Mutual Funds
Mutual funds classified as these issue shares to investors depending on the fund's net asset value (NAV) per share.
Mutual funds classified as open-end mutual funds issue shares to investors depending on the fund's net asset value (NAV) per share.
Investors purchase shares of an open-end mutual fund directly from the mutual fund at the net asset value (the value of the fund's underlying securities) per share as opposed to the existing shareholders.
In simple words,
- Investors buy shares in an open-end mutual fund directly from the mutual fund rather than current shareholders.
- New investors pay the per share price for a stake in an open-end mutual fund, known as the share price or net asset value per share.
- Open-end mutual funds are required to keep a large cash reserve, reducing the investors' overall returns.
A group of investor funds pooled together to pursue a single investing goal is an open-end mutual fund. As the name suggests, an open-end mutual fund is accessible to new investors.
Shares of an open-end mutual fund are purchased directly from the fund manager by investors. In contrast, investors buy from existing shareholders in closed-end mutual funds.
Closed-end mutual funds, which trade on the market like stock, are priced differently than open-end mutual funds. Shares in open-end funds can be purchased and sold directly by investors at a price based on the value of the underlying securities.
The net asset value (NAV) is determined on each trading day, often after the day, by dividing the market value of the fund's assets, less expenditure, by the number of shares held by investors.
One of the first open-end funds offered by the investment corporation, Fidelity's Magellan Fund, sought to increase in value. It was established in 1963, and in the late 1970s and early 1980s, when it consistently outperformed the stock market, it rose to legendary status.
It had a lifetime return of 16.14% as of June 2021. Peter Lynch, the fund manager, was almost a household name.
When the fund's assets reached $100 billion in the US, it was so well-liked that Fidelity decided to close it to new investors for over ten years in 1997. Then, in 2008, it reopened.
How does an Open End Mutual Fund work?
Shares are issued by an open-end fund as long as investors demand them. Since investments are constantly welcome, it is known as an open-end fund. Selling shares removes them from circulation, but buying shares prompts the fund to issue new, replacement shares.
At their NAV, shares are purchased and traded as needed. The value of the fund's underlying securities serves as the daily foundation for calculating the net asset value, which is done at the close of each trading day.
The fund may sell some of its holdings to reimburse the selling investors if a significant number of shares are redeemed.
An open-end fund offers investors a simple, inexpensive option to pool funds and buy a diversified portfolio that reflects a specific investment aim. Investment goals can include, among other things, investing in large or small-cap companies for growth or income, etc.
Additionally, the funds might focus investments on particular nations or industries. Finally, an open-end fund is often easy to join and does not require a significant investment, making it available to investors of all experience levels.
Occasionally, a fund will close to new participants if its investment management decides that the fund's total assets are now too vast to carry out its stated aim efficiently. In addition, some funds may, under rare circumstances, be closed to new investments from current fund shareholders.
Since open-end and mutual funds are almost interchangeable, many investors might need to know that other types of funds are available. Even so, this kind of investment fund is not the first kind of investment fund.
According to the Closed-End Fund Center, closed-end funds have been around since 1893, making them considerably older than mutual funds.
What are the pros and cons of open-end mutual funds?
Open-Ended Mutual Funds have the advantages of increased liquidity, acting like a systematic investment plan, and investing wisely to reap benefits throughout the market cycle.
Here are a few benefits of open-ended mutual funds:
- High liquidity
Investors may redeem an open-ended fund's units on any business day. This gives your investment portfolio the crucial element of liquidity.
While numerous investment options give competitive rates, many have lock-in periods that make your money inaccessible until maturity. You can benefit from the utmost liquidity by using open-ended mutual funds.
- The presence of SIP
Because you can purchase units on any working day, you can set up a systematic investment plan, or SIP, to invest a certain amount in the program regularly.
Salaried investors and those without an available investible corpus will benefit the most from this. Additionally, investing via SIP can assist you in starting from the beginning with a corpus.
- Results throughout various market cycles
An open-ended fund's historical performance can give investors a rapid idea of how it has fared over various market cycles because investors can buy or redeem units from the fund house. You may therefore invest wisely and by your goal thanks to this.
Investors can face risks related to the changes in the market and volatility. Here are a few drawbacks of open-ended mutual funds in brief:
- Extremely volatile
An open-ended mutual fund's NAV changes based on how its underlying securities perform. As a result, open-ended funds are highly volatile and subject to market risks.
These funds always carry some level of market risk, notwithstanding the fund manager's efforts to reduce volatility by diversifying his holdings.
- Affected by market risk
Although an open-ended fund manager makes an effort to keep a diversified portfolio, they are nevertheless subject to market risk. In addition, the underlying benchmark fluctuations cause the funds' NAV to change over time.
- No Room for Opinion Sharing
Open-ended funds typically assign highly competent fund managers to judge securities for the fund. As a result, an investor is prevented from contributing his opinions in deciding the fund's asset mix.
Open-ended funds vs. Close-ended funds
When you invest in a close-ended mutual fund scheme, your money is locked in for a set amount of time.
Closed-ended schemes can only be purchased during the NFO (new fund offer) period, and the units can only be redeemed after the scheme's tenure (lock-in period) or NFO has passed.
After the lock-in period, certain closed-ended funds do, however, become open-ended. Occasionally, AMCs will transfer the proceeds of closed-ended funds after the maturity term to another open-ended fund.
However, the investors in the aforementioned closed-ended fund must agree to do this.
Some investment experts argue that when comparing open-ended and closed-ended funds, the closed-ended fund's lock-in period guarantees that the fund's assets will remain stable due to the specified lock-in.
It gives the fund manager flexibility to build a portfolio with long-term growth potential without worrying about redemption outflows as in an open-ended fund.
Whether open-ended funds are superior to closed-ended or the opposite is impossible. A fund's performance, whether open-ended or closed-ended, is influenced by its category, management, and investment philosophy.
After the NAV increases by 5%–10%, some open-ended fund investors quickly redeem their units to realize short-term gains.
The investors who continue to hold funds suffer as a result. However, because the lock-in period restricts early redemption and safeguards the interests of long-term investors, closed-ended funds are preferable in certain circumstances.
Open-ended funds can be helpful for someone who wants an annualized return between 12% and 15% but needs more market understanding.
The fact that professionals manage these funds, that the NAV is updated every day, and that they are extremely liquid gives investors a minor advantage over closed-ended funds.
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