What are Open-Ended Mutual Funds?
Open-ended mutual funds, as their name suggests, are always open to investment. These funds have no maturity date meaning the fund can continue to exist forever. The AMC running an open ended fund can issue as many units of these funds to the investors as they wish. This means investors can purchase and sell units of these funds whenever they please on the basis of that day’s Net Asset Vale (NAV).
It is safe to say that when we talk about mutual funds, a large proportion of existing mutual fund schemes are open ended mutual funds. Take a list of top mutual funds based on returns for example. Now, check their fund details, you’d most likely find that these funds are open ended schemes. Some examples of these funds are: SBI PSU Direct Growth, HDFC Infrastructure Fund, ICICI Prudential India Fund, etc. Let’s understand how open ended mutual funds work, how they are different from close ended funds and what’s the right choice for you.
How do Open-Ended Mutual Funds work?
When an AMC introduces a mutual fund scheme it floats the same through an NFO (New Fund Offer). NFO is basically an IPO for mutual funds. This process helps the mutual fund house collect funds for its newly launched scheme.
The AMC then issues a fact sheet that provides key details of the mutual fund. On top of this document it is specified whether the scheme is open-ended or close-ended. Close-ended schemes have a fixed maturity date, and investors can only invest while the NFO (New Fund Offer) is open. We've explained close-ended mutual funds in detail in another article. Read about it here.
An open ended scheme, however, has no specified expiry date. Investors can continue to invest in these funds even when the NFO is over. When the NFO is introduced, units are distributed on the basis of a face value or notional value, but once the mutual fund becomes active and you decide to invest in the fund; you get units on the basis of the current day NAV (Net Asset Value).
Since these funds have no maturity date, investors can redeem funds as and when they want. The funds are again redeemed on the basis of the prevailing days NAV. Just like any other mutual fund, these schemes are managed by a professional fund manager. You can choose to invest in these schemes either through a SIP (Systematic Investment Plan) or Lump Sum.
What are the advantages of Open-Ended Mutual Funds?
Here are the top advantages of investing in open-ended funds:
High Liquidity: Since you can buy and sell mutual funds units on any working day, it means you can liquidate your investments whenever you choose. This feature provides investors with quick access to funds.
Transparency: Investors can easily access information about the securities held in the fund, its historical performance, and the track record of the fund manager. This transparency allows investors to make an informed investment decision.
Convenience: Open-ended mutual funds allow you to invest via SIP, STP or as a lump sum. This gives investors the convenience to invest as per their financial goals.
Professionally Managed: Since these funds are professionally managed, it saves you the hassle of actively tracking the market. These managers analyse market conditions, research potential investments, and adjust the portfolio according to the fund’s investment objectives.
What are the disadvantages of Open-Ended Mutual Funds?
Here are the key disadvantages of open-ended mutual funds:
Market Risk: Open-ended funds are vulnerable to stock market fluctuations, which can impact the value of the investment. Even if the fund manager diversifies the investments, he/she cannot eliminate stock market risk.
Vulnerable to Huge Inflows & Outflows: Unlike close-ended mutual funds, these schemes can see huge inflows and outflows. Quick outflows may force the mutual fund manager to sell the securities at unfavourable prices, causing huge losses for investors in the scheme.
Exit Load: When selling units of mutual funds, there is often an exit load fee, which is a percentage of the unit's value. This fee is levied if you exit the fund within a certain period. This can potentially reduce returns for your mutual funds.
How is the price (NAV) of Open Ended Mutual Funds determined?
NAV or Net Asset Value represents the market value of a fund for each share. In simple words, this is the price at which you purchase one unit of a mutual fund. NAV is calculated by dividing the market value of securities by its outstanding shares. While managing these funds, fund managers incur various expenses, such as administrative costs and management fees. These expenses are deducted from the fund's total asset value to determine the final NAV. So, the formula goes as:
NAV = (Asset - Liabilities)/ Outstanding Shares
NAV, or Net Asset Value, fluctuates as the value of a mutual fund’s holdings changes. Let’s break this down with an easy-to-follow example: Imagine you're a college student with a keen interest in the stock market and finance. Over time, you build solid knowledge and start managing your own investments. You actively research, buy, and sell stocks to grow your portfolio.
Your friends notice your success and approach you for help. They want to invest their savings but lack the expertise. Five of them decide to pool their money with you, trusting you to manage it and aim for good returns. Essentially, you've created a "mutual” fund" for your group.
Here’s how much each friend contributed:
- Friend 1: ₹50,000
- Friend 2: ₹65000
- Friend 3: 100,000
- Friend 4: ₹75000
- Friend 5: ₹25000
The total investment you now have is ₹3,15,000. You decide to distribute units of mutual funds to your friends at a face value of ₹10. This is what the distribution looked like:
| Investors | Investment | Units (₹10 per unit) |
| Friend 1 | ₹50,000 | 5000 |
| Friend 2 | ₹65,000 | 6500 |
| Friend 3 | ₹100,000 | 10000 |
| Friend 4 | ₹75,000 | 7500 |
| Friend 5 | ₹25,000 | 2500 |
Now, say you invested the total corpus of ₹3,15,000 across 5 different stocks in the stock market. On Day 2 the value of ₹3,15,000 changed to ₹3,20,607. This means you earned a profit of (3,20,607 - 3,15,000)* 100 = 1.78%.
Which also means that the value of your asset per share also increased by 1.78%. This makes your revised NAV as ₹10 + 1.78% = ₹10.178. Say on Day 2, Friend 4 decides he wants to redeem his funds; he’d now get proceeds on the basis of the new NAV i.e; ₹10.178. Friend 4 will now receive 7500 * 10.178 = ₹76, 335.
In the above example you acted as an asset management company, your friends as investors and the continuous buying and selling of funds represents an open ended scheme. The above example was of course simplified. In reality the investment amount is huge and more complex.
How are Open Ended Mutual Funds different from Close Ended ones?
Unlike open ended mutual funds, close ended mutual funds have a pre-defined maturity date. This means that investors can only invest in these funds when the NFO comes out. Once the NFO is closed, your investment is locked for the specified period until the fund matures. On the other hand, An open ended mutual fund investors can stay invested in the fund for as long as they want. They can redeem their funds or invest in a new open ended scheme at any point of time at the funds current NAV.
When you choose to invest in an open ended fund, you can either make a lump sum investment or opt for a SIP (Systematic Investment Plan). While, in the case of close ended funds, you can only invest a lump sump amount.
Another aspect that differs the two are that when you invest in close ended funds there is no proven track record of returns the funds have generated, this is because it accepts investors during the inception of the fund. With an open ended fund however, you can check historical performance to assess if you’d like to invest in the fund or not.
Should I invest in Open Ended Funds or Close Ended Funds?
The decision to invest in an open ended or close ended fund depends on your risk tolerance and liquidity preference. A close ended fund would lock in your funds for a specified period of time until maturity. They allow you to trade funds in the secondary market but finding the right buyer is often a challenge due to its nature of redemption.
With open ended funds on the other hand an investor enjoys the flexibility of entering and exiting a fund at any point of their investment journey. Moreover, since open-ended schemes allow SIP, the investors also benefit from rupee-cost averaging; which is otherwise missed in a close-ended scheme.
In conclusion, if you prioritize liquidity and the ability to adjust your investments as needed, open-ended funds may be more suitable. Conversely, if you're comfortable with a fixed investment period and are seeking potentially higher returns with less frequent access to your funds, closed-ended funds could be considered.
How much tax do I have to pay in an Open Ended scheme?
Like with any other investment, any capital gains earned from mutual funds are subject to taxation. The rate of tax applicable will vary depending on whether the fund is an equity fund or a debt fund.
If a mutual fund invests at least 65% of its assets in equities, it's classified as an equity fund for tax purposes. Here's how the taxation works based on your holding period:
Short-term capital gains: If you sell your mutual fund units within 12 months, the gains are known as short-term capital gains. They are taxed at 20%.
Long-term capital gains: If you sell your mutual fund units after 12 months, the gains earned are called long-term capital gains. You don’t have to pay any taxes on gains up to ₹1.25 lakh in a financial year. While returns above that are taxed at 12.5%.
If a mutual fund allocates at least 65% of its assets to debt instruments, it's classified as a debt fund for taxation purposes. The tax implications for debt funds are as follows:
Investments made on or after April 1, 2023:
Gains made on debt funds will be taxed as per the investor’s income tax slab rate irrespective of the holding period.
Investments made before April 1, 2023:
Herein, taxation on gains made will be determined by the holding period. If you sell your mutual fund units within 24 months, gains will be taxed at your prevailing income tax slab rate. However, if you sell your fund after 24 months, you will have to pay a tax of 12.5% (no indexation benefit) on your returns.
Frequently Asked Questions (FAQ)
Can I buy or sell units of an open ended mutual fund at any time?
Yes, you can buy or sell units of an open ended mutual fund scheme at any point in time. These schemes have no lock-in period which ensures investors have liquidity while maintaining their investments. The units are sold on that day's prevailing Net Asset Value.
How often is the NAV of an open-ended mutual fund calculated?
The NAV of an open-ended mutual fund is calculated daily after the market closes. It determines the price at which investors can buy or redeem shares.
Can an open ended mutual fund suspend redemptions in certain situations?
In very rare circumstances, mutual funds might suspend redemptions. This is done when the fund manager is afraid that redemptions in unexpectedly high amounts can impact the liquidity of the fund.
A common situation due to which a fund may impose temporary suspension on redemptions is during cases of extreme market volatility. When the market takes a downturn, investors are likely to withdraw funds out of fear, an unusually high redemption rate can impact the valuation of the assets of a fund.
Such suspensions are implemented to prevent the forced sale of assets at unfavorable prices, which could negatively impact the fund's overall value and harm remaining investors. By temporarily halting redemptions, fund managers aim to maintain stability and ensure equal treatment for all shareholders.
What kind of fees and expenses are associated with open-ended mutual funds?
When you invest in mutual funds, certain fees and charges are associated with it. It’s important you understand all applicable fees as this impacts your returns on investment. Common expenses on open ended schemes are:
Exit Load: Exit load is a fee charged by the mutual fund house. It is withdrawn on early redemption of funds. Mutual funds specify a stipulated period of time, if an investor withdraws a fund before that period they are required to pay a small fee.
Management Fees: Mutual fund houses charge management fees from investors. This fee is paid to the fund managers for offering their time and expertise in managing the funds.
Maintenance fees: Maintenance fees are charged by platforms where you invest your mutual funds in return for managing your funds. Note: INDmoney charges 0 maintenance fees on your mutual funds.
Can I automate my investments in open ended mutual funds via SIP?
Yes, you can automate your investments in open-ended mutual funds using a Systematic Investment Plan (SIP). A SIP allows you to invest a fixed amount regularly, such as daily, weekly, or monthly, in your chosen mutual fund scheme. On the INDmoney app, you can create a free account, explore various open-ended mutual fund schemes, and start a SIP with just a few clicks.
How do I track the performance of my open ended mutual fund investments?
To track the performance of your mutual funds, two approaches can be taken. One to check the fact sheet of the fund. Fund houses release a fact sheet of their fund on a monthly basis. This is a one-page document that comprises the key performance metrics of the fund. The other is to use an app that can help you analyse the performance of your mutual funds and actually make sense of it.
On INDmoney, for example, we offer detailed analytics on how your mutual fund’s performing compared to its benchmark, its key allocations, and what major shifts the fund has taken. And that’s not all, on the app you can also track multiple mutual funds and get a comprehensive analysis of your funds. You can know what funds are underperforming, what’s the average investment in your peer group and more.
Do open ended mutual funds have entry or exit loads?
Investors are required to pay an exit load on their mutual funds. However SEBI put a restriction on entry loads in 2009. This means no platform or AMC can charge you an entry load for investing in mutual funds. Read the funds related documents carefully to understand the exit load charges on your investments.