Open-ended mutual funds: How do they work and what are their advantages?

Open-ended schemes form a bulk of the mutual fund landscape in India, offering flexibility and liquidity to investors. This has made mutual funds popular among retail and institutional investors alike. Open-ended funds allow investments and redemptions at any time. Unlike their close-ended counterparts, open-ended schemes do not have a fixed maturity date, making them suitable for both short-term liquidity needs and long-term wealth creation potential.
The appeal of these funds also lies in their variety. With so many categories of schemes to choose from, you can find open-ended funds for diverse financial goals.
- Table of contents
- What are open ended funds?
- How do open ended funds work?
- Advantages and disadvantages of open-ended funds
- Types of open-ended funds
- Key differences between open ended funds and close-ended funds
- Who should invest in an open ended mutual fund?
- How to redeem open ended mutual funds?
- Tax on open ended funds
- How to evaluate open ended funds before investing?
- Should you invest in open-ended mutual funds?
What are open ended funds?
Simply put, open-ended mutual funds are investment vehicles that allow investors to buy or sell units on any business day. In comparison, you can only invest in close-ended funds during the initial offering period and redeem funds upon maturity. Thus, liquidity is one of the defining characteristics of open-ended funds.
While a handful of open-ended funds (such as Equity Linked Savings Schemes) have a lock-in period, most do not. However, there may be a nominal exit load for a certain period (which can range from a few weeks to a year) for some schemes. This is done to encourage long-term investing.
The Net Asset Value (NAV) of an open-ended fund is calculated at the end of each trading day based on the market value of its underlying assets. Investors can purchase units or redeem from the fund house – either directly or through an intermediary – at the prevailing NAV. Depending upon the time at which the transaction is processed, the investor may either get the same day’s NAV or the next business day’s NAV.
Key features of open-ended mutual funds include the following.
- No maturity period: Investors can stay invested as long as they wish.
- Buy or sell units at any time: Transactions can be executed on any business day.
- Daily NAV calculation: The value of units is updated at the end of each trading day based on market fluctuations.
How do open ended funds work?
Open-ended mutual funds pool money from multiple investors to create a diversified portfolio of securities such as stocks, bonds, or a mix of both. The fund manager actively manages this portfolio to achieve the stated investment objectives. Here's how they operate.
- Investments and redemptions: Investors can buy or sell units at any time at the prevailing NAV. When new investments are made, additional units are created; when redemptions occur, units are removed from circulation.
- Daily NAV calculation: The NAV reflects the total market value of the fund's holdings divided by the number of outstanding units. It is updated daily to account for market movements.
- Liquidity management: Fund managers seek to maintain a portion of assets in liquid instruments to handle redemption requests without disrupting long-term investments.
Advantages and disadvantages of open-ended funds
Like all other investment avenues, open-ended funds have several advantages as well as a few drawbacks.
Advantages
- Liquidity: Investors can redeem units at any time without waiting for a maturity period.
- Diversification: These funds invest across various asset classes and sectors, mitigating risk.
- Professional management: Experienced fund managers optimise return potential by making informed investment decisions.
- Flexibility: Open-ended schemes offer investments through Systematic Investment Plans (SIPs) or lumpsum. SIPs allow you to invest a fixed amount at regular intervals – daily, weekly, monthly etc., enabling you to invest in affordable instalments.
- Transparency: Daily NAV updates and regular disclosures enable informed decision-making.
Disadvantages
- Market risk: The NAV fluctuates daily due to market volatility.
- Exit loads: Some funds charge a fee for early redemption.
- Cash reserve requirements: To meet redemption demands, fund managers may keep a portion in cash or liquid assets, potentially limiting returns during bull markets.
- Emotional decision-making: The quick redemption process may tempt some investors to withdraw their units before their goals or to exit the investment in a panic during to market volatility.
Types of open-ended funds
Mutual funds can be categorised based on asset class or investment strategy. Here are some types:
Equity funds (invest chiefly in company stocks)
- Large-cap funds
- Mid-cap/small-cap funds
- Multi-cap funds
- Sectoral/thematic funds
- Equity Linked Savings Schemes (ELSS)
Debt funds (invest chiefly in bonds and other fixed-income securities)
- Liquid funds
- Short-duration/long-duration funds
- Corporate bond funds
- Credit risk funds
Hybrid funds (invest in equity and debt instruments)
- Balanced advantage funds
- Dynamic asset allocation funds
Other funds
- Index funds
- Fund of Funds (FoFs)
Solution-oriented funds (lock-in period of 5 years)
- Retirement fund
- Children’s fund
Each type caters to specific investment goals and risk appetites.
Key differences between open ended funds and close-ended funds
Feature | Open ended funds | Close ended funds |
---|---|---|
Liquidity | High; units can be redeemed anytime | Low; units are locked until maturity |
Investment period | No fixed maturity | Fixed maturity period |
Entry/Exit | Anytime | Only during New Fund Offer (NFO) |
NAV pricing | Daily NAV | Market price on exchanges |
SIP/STP/SWP | Available | Not available |
These distinctions make open-ended mutual funds more suitable for investors seeking flexibility.
Who should invest in an open ended mutual fund?
Open-ended mutual funds can be suitable for the following:
- First-time investors: SIP options make it easy to start with small amounts.
- Long-term wealth builders: Equity-oriented open-ended schemes are suitable for long-term goals like retirement or education.
- Risk-averse individuals: Debt-oriented open-ended schemes offer relative stability with moderate return potential.
- Investors needing liquidity: The ability to redeem units anytime makes these funds suitable for those who prefer convenient access to their money or the option of topping up their investments at any time.
How to redeem open ended mutual funds?
Redeeming units in an open-ended scheme is straightforward.
- Online platforms: Log in to your mutual fund account or investment platform and select "Redeem."
- Directly with AMC: Submit a redemption request through the Asset Management Company (AMC).
- Through an MFD: Contract your mutual fund distributor to place a redemption or purchase request.
- Registrar & transfer agents (RTAs): Use services like CAMS or KFintech for redemption.
Tax on open ended funds
Equity-oriented open ended funds
- Short-Term Capital Gains (STCG)
- Applicable for holdings of less than 12 months.
- Taxed at 20%
- Long-Term Capital Gains (LTCG)
- Applicable for holdings of more than 12 months.
- Gains up to Rs. 1.25 lakh per financial year are tax-exempt.
- Gains exceeding Rs. 1.25 lakh are taxed at a flat rate of 12.5%.
Debt-oriented open-ended funds
- Taxed as per the investor’s income tax slab, regardless of the holding period.
Hybrid funds
- Taxation depends on the portfolio composition
- Equity-oriented hybrid funds (≥65% equity exposure) are taxed like equity funds.
- Debt-oriented hybrid funds (<65% equity exposure) are taxed like debt funds.
How to evaluate open ended funds before investing?
- Investment objective: Align the scheme's investment objectives with your goals.
- Expense ratio: Lower expense ratios mean higher net returns.
- Fund manager expertise: A skilled manager can significantly impact performance.
- Risk metrics: Evaluate standard deviation, beta, and Sharpe ratio for risk assessment.
Should you invest in open-ended mutual funds?
Open-ended mutual funds are versatile investment options suitable for many investors due to their liquidity, diversification, and accessibility features. However, they do carry market risks and may not be ideal for those seeking guaranteed returns with minimal risk like fixed deposits.
Conclusion
Open-ended mutual funds stand out as a flexible and investor-friendly financial instrument. Their ability to adapt to varying financial needs – be it short-term liquidity or long-term wealth creation – can make them a suitable addition to an investment portfolio. However, like any financial product, they require careful evaluation based on individual goals, risk tolerance, and market conditions before investing.
FAQs
Is SIP possible in open ended funds?
Yes, SIPs are available in most open-ended schemes, allowing systematic investments over time.
Which is better – open-ended or closed-ended funds?
The fund that is more suitable depends upon your investment goals and liquidity requirements. Open-ended funds offer greater flexibility and liquidity compared to closed-ended ones. However, fund managers of close-ended funds may have more flexibility in managing their portfolios as they do not have the pressure of maintaining liquid reserves.
Is it good to invest in an open ended mutual fund?
Yes, if you seek liquidity and professional management and are comfortable with market risks, an open-ended mutual fund can be a suitable avenue.
How do I know if a mutual fund is open-ended?
Check the fund's prospectus or details on its website; it will explicitly state if it’s an open-ended scheme. The scheme information document also has this information.
Do open-ended funds have NAV?
Yes, the NAV is calculated at the end of each business day based on the market value of underlying assets.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.