What are Open-Ended Funds?
Mutual funds come in two forms: open-ended and close ended. So what is an open-ended mutual fund? An open-ended mutual fund is one that is always open for investment and never closed. Hence investors can invest whenever they want, and exit whenever they choose. Most mutual funds are open-ended funds. When new investors make large purchases, fund managers of open-ended funds purchase more shares from the stock market. When investors redeem mutual funds, the fund managers sell some of the assets under management to pay for the redemptions.
An open-ended fund is an inexpensive way for investors to come together and pool their money to purchase shares. Since the money is pooled, individual investors will be able to invest in stocks using only small sums. This makes it easy for them to enter the stock market and get the benefit of a diversified set of stocks. Companies also benefit because their shares will be easily accessible and traded, and they will be able to raise money from the stock market whenever they need to raise funds.
How do open-ended funds work?
Now we know what is an open-ended mutual fund, let’s see how it works. It all begins when a mutual fund decides to start a new scheme and open it to new investors, in what is called a New Fund Offering (NFO). The subscriptions received from the new investors are then invested in various shares depending on the nature of the scheme. For example, if it’s a large-cap diversified fund, the amount will be invested in the shares of large-cap companies. An index fund will invest in the shares that make up an index, like for example the BSE Sensex.
Unlike shares, open-ended mutual funds are not listed on any exchange, and investors buy and sell units directly from the company managing the funds. The price at which investors buy and sell units of a fund is called net asset value or NAV. NAV is the current net value of the fund’s assets divided by the total number of units outstanding. Mutual fund companies are required by law to determine the price of their shares each business day.
When you invest in a mutual fund, you are charged an entry load, which is added to the NAV. An entry load is something like a sales charge – to enable the company to pay for distributing the funds. Some mutual funds also charge an exit load, mainly to deter investors from exiting a scheme. Many have now done away with exit loads.
Mutual funds also charge what is called expense ratio to investors. This is the amount needed to pay for administrative and marketing costs. If the expense ratio of a mutual fund is 2 percent, it means that 2 percent of assets under management are used to pay for expenses each year. When you invest in an open-ended fund, you must ensure that expense ratio is kept at minimum, since high expense ratios will reduce your returns.
Open-ended funds and closed ended funds
Now that we’ve explained what is an open-ended mutual fund, we should also take a look at closed ended funds. A close ended fund raises a fixed amount from the public through an initial public offering (IPO) in exchange for shares. The shares are then traded on the stock exchange. The interesting thing about closed ended funds is that their price is not determined according to NAV, but by demand and supply. So shares of a closed ended fund could end up trading at a discount or at a premium to its NAV. Unlike open-ended funds, whose NAV is declared at the end of each business day, prices of closed ended are dynamic and change by the second. Since they are traded on the exchange, closed ended funds are much more liquid than their open-ended counterparts.
Benefits of open-ended funds
Enables wider participation: An open-ended mutual fund enables wider participation in the stock market by making it easier for small investors. You need only small sums to invest, and get exposure to a much more diversified portfolio.
High liquidity: Since there’s no lock-in period, it’s very easy to buy and sell units of an open-ended fund. You can redeem units whenever you need cash, and you can get the amount in three or four days.
Easy to invest: Investing in a fund is very easy once you have done the KYC (know your customer) formalities. You can do it online as well.
How to invest in open-ended mutual funds
Once you have understood what an open-ended fund is, it’s time to invest. There are several ways of buying open-ended mutual funds – online, offline, through a distributor or directly from the mutual fund company. Here are the steps you need to take:
Get your KYC done: Get a KYC form from your mutual fund company or distributor, fill the form, provide a passport-size photograph, and proofs of identity and residence. You will need copies of your PAN card, passport or Aadhaar card.
Select the scheme: After doing the KYC, select the scheme you want to buy. You can do a comparison of the performance of various open-ended mutual fund schemes on the web sites of Crisil, Morningstar and Value Research. You can also download the Angel BEE mutual fund app to check for mutual fund rankings.
Fill the mutual fund form: After that, you will need to fill the mutual fund form and hand it over to the company or distributor along with the cheque for the amount. A distributor may offer you many more choices than a mutual fund company.
Buying online: The most convenient way to buy an open-ended mutual fund is online – it’s quick and easy. Download the Angel Bee mutual fund app if you want to do it from your mobile phone.