Open Ended Vs Close Ended Mutual Fund | Investopaper (2024)

By: Rupesh Oli

What is a Mutual Fund?

Mutual fund refers to professionally managed investment funds, where the professionals pool money from various investors and invest it in securities such as stocks, bonds, short-term debt, money market fund, or hybrid funds with the prime motto to generate higher returns. When investors buy a certain number of shares in a mutual fund, it represents their ownership of the fund and income generated by it.

While higher prices of stocks currently trading at, can be regarded as the barrier for investors to purchase the stocks in the secondary market; mutual funds on the other hand provide a chance for small investors to access the diversified and professionally managed fund at a lower price that individuals with no huge capital can access too. The fund collected is invested into various securities that differ based on the investment objectives and the type of return a particular mutual fund desires to garner.

When it comes to the value of the mutual fund that an Asset Management Company manages, it depends on the performance of securities they invest in. When an investor purchases a certain chunk of shares of a mutual fund, s/he is actually procuring the part of portfolio value the mutual fund is representing. The investment done in a mutual fund is different than the one done in stocks, as mutual fund shares do not give any voting rights to their shareholders unlike the stocks tend to offer. Further, a unit of share an investor possesses on a mutual fund represents the investments in various stocks rather than just one holding.

Net Asset Value (NAV) per share represents the price of a mutual fund share, calculated by dividing the total value of securities of the portfolio by the total number of outstanding shares whereby outstanding shares refer to the total number of shares held by the investors in the particular mutual fund. Unlike stocks, mutual funds’ NAV does not fluctuate during market hours. Instead, it gets settled at the end of each trading day. It implies that the price of the mutual fund only gets settled when NAV per share gets updated.

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Advantages of Mutual Fund

• An investment done on a mutual fund automatically diminishes the risk as it represents the diversification done through holding various securities. It perfectly relates to the say “Don’t put all your eggs in one basket”.

• Mutual fund companies hire professionals to supervise the portfolio be it open-end or close-end mutual funds.

• Mutual funds are transparent as they are required to report their performance through which investors can easily track the performance of mutual funds they have invested in.

• In terms of liquidity, mutual funds favor the investors, unlike the fixed deposit as investors can easily redeem their shares at any time as per the current Net Asset Value (NAV) per share.

• Mutual funds are affordable for investors as an investor can grab the unit of shares at a relatively lower price than any other expensive stocks currently trading on the market.

• One can choose whether to go with SIP (Systematic Investment Plan) or one-time investment as per the budget and convenience. If one possesses a surplus amount to invest in, s/he can go with the lumpsum investment tactic. On the contrary, s/he can go with investment on a monthly or quarterly basis when possessing a lesser amount of money.

• When the price of the securities in the fund rises, it leads to the capital gain which in turn gets distributed to the shareholders of a mutual fund.

Disadvantages of Mutual Fund

• While diversification lowers your risk, on one hand, it can dilute your profit on the other hand. It is because you would be depriving yourself of the profit you could have gained through holding the limited number of selected stocks and as their price skyrocketed, you could have easily booked huge profit. However, you already diversified your portfolio through investing in mutual funds, which implies that you are averaging your risk but depleting your profit which you could have garnered at once.

• The cost of managing the fund is high if operational costs, the salary of the fund manager and market analysts are to be taken into consideration.

• Mutual funds do not provide guaranteed returns as the market is volatile in nature and depicts a fluctuating pattern. Hence, as an investor, one must be ready to accept the depreciation in the value of a mutual fund.

• As an investor, you possess no control over your investment as mutual funds are managed by professionals and a team of analysts.

• There is a tendency to lose the money you invest as the securities can go down in value as well, based on market conditions. Further, the dividend and interest income you tend to gather also fluctuate as per the market condition.

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Open-Ended Mutual Funds

Open-end mutual funds have no limit on the number of shares offered and they are bought and sold on demand. When an investor buys shares in open-end mutual funds, the shares are issued by the fund and when an investor sells the shares, they are bought back by the fund itself. When the redemption is done (shares are sold), the fund pays the investor in return.

Typically, at the end of each trading day, Net Asset Value (NAV) per share is calculated and shares of the open-end mutual fund are bought and sold directly from that particular NAV per share. It is due to which open-end mutual funds are not traded normally on exchanges like close-ended mutual funds or stocks.

Pros of Open-Ended Mutual Funds

• Suitable for pension fund investors as open-end mutual funds have long maturity and hence best suits for those with long-term investment horizons.

• Offers higher liquidity as one can redeem units of funds they hold as per their convenience on prevailing Net Asset Value (NAV).

• Optimal investment option for salaried investors as they can decide to enter the fund as per their choice with SIP (Systematic Investment Plans).

• As large cash reserves are a compulsion to meet shareholders’ redemptions, it provides more security to the investors.

• Investors can make a well-informed decision as a performance track record of open-end mutual funds across different market cycles is available, unlike close-ended funds.

Cons of Open-Ended Mutual Funds

• Open-end mutual funds are priced just once at the end of each trading day. Hence, investors have to wait till the end of the trading day to gain insights into whether they gained or lost.

• Vulnerate to large inflows and outflows of cash. For instance, the sudden outflow of cash leads an open-end mutual fund manager to sell out the holdings at very minimal pricing, ultimately impacting portfolio holders of the open-end mutual fund.

• Must maintain large cash reserves in order to meet shareholders’ redemptions. Since a large portion is kept in reserve, it automatically lowers down the yields.

• Investors might get persuaded by greed to invest more money in a bullish market and redeem on a bullish trend due to fear.

• Higher management fees as the management team must continually adjust holdings to cope up with investor demand.

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Close Ended Mutual Funds

Close Ended Mutual Funds issue shares to the general public through Initial Public Offering (IPOs). After that, the shares get listed on the stock exchange and investors can trade the shares of close-end funds like any other stock. Investors must sell their shares to another investor who wants to buy; s/he cannot sell the shares back to the fund, unlike open-end mutual funds.

The price an investor receives for his/her shares may be significantly different than NAV, be it higher than NAV or lower than it. A fixed number of shares are issued and cannot be increased or decreased in close-end mutual funds. The rest depends on the demand and supply game. Your investment gets locked in for the specified period of time in close-end mutual fund.

Pros of Close Ended Mutual Funds

• Possess attractive and periodic distributions, hence providing regular cash flow to the investor. The rest depends on investors whether they want to reinvest the amount to buy even more units of shares or use it to manage their expenses.

• Since there is no pressure from the side of investors to constantly buy and redeem the fund, close-end mutual fund has a stable asset structure to keep it fully invested.

• Possess minimal marketing expense and lower turnover, hence, needs fewer expenses to manage and operate the fund if compared to open-end funds.

• Provides higher returns when compared to open-ended mutual funds.

• Provides a second chance to those who could not acquire close-end mutual funds through IPO, as they can easily purchase it in the secondary market like they use to do with the stocks. They can use stop order, market order, or limit order too.

Cons of Close Ended Mutual Funds

• Volatile in nature as supply and demand of market affect NAV of close-end funds.

• If you act as the trader in case of close-end funds, you are paying more commissions to your broker for sure. So, you need to keep expenses in concern so that it does not hamper your overall investment objective.

• No liquidity exists during the lock-in period. Redemptions can only be done once the mandatory lock-in period gets over.

Open Ended Vs Close Ended Mutual Funds

Current Status of Mutual Funds in Nepal

History of mutual funds started with the establishment of NCM Mutual Fund 2050 by Nepal Industrial Development Corporation (NIDC) Capital Market in Ashad 19, 2050 BS.

Asset Management Companies (AMCs) are responsible for mutual fund management outside Nepal, whereas banks that fall under category ‘A’ act as AMCs for mutual funds here in Nepal.

As of January 2, 2021, 26 close-end mutual fund schemes are trading on Nepal Stock Exchange (NEPSE) which are listed below.

Among 26 closed-end funds mentioned above, Siddhartha Equity Fund and NIBL Samriddhi Fund -2 possess the highest fund size of 150 million NPR each. Sanima Equity Fund has a high monthly NAV of 15.71 NPR followed by NMB 50 with 14.61 NPR as of Mangsir 2078.

Taking a look at open-end mutual funds, only 4 of such funds exist showcased below.

Open-end mutual fund has just started in Nepal as NIBL Sahabhagita Fund is the first open-end mutual fund in Nepal issued to the general public on Jestha 19, 2076. NMB Saral Bachat Fund – E has the highest fund size of 55 crores NPR followed by NIC Asia Dynamic Debt Fund of 50 crores NPR.

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