Open-ended fund has a higher expense ratio as they are actively managed. Close-ended funds have a longer investment horizon making expenses lower.
Investments can be tricky things. Right from the number of products to the plethora of choices, more confusion is bred in the minds of Investors. The choice of investing in debt or equity can be mind-boggling. The awareness of investment basics can be a first step towards the victory. There are mainly three fund-types. Open-ended funds, Closed-ended funds and ETFs.
In open-ended funds, shares are bought and sold on demand at their net asset value, or NAV. It is based on the value of the fund’s underlying securities and is generally calculated at the close of every trading day. Investors have the option to buy shares directly from the fund. These are traded on a continual basis and allow for easier investment and redemption process with minimal constraints. Investors and prospective investors have the flexibility to choose between lump sum investment or a periodically scheduled payment ( SIPs and SWPs) into the fund.
Close-ended funds have a fixed number of shares and are traded amongst the investors on the exchange. These funds are open for investments only at a specified period and this, in turn, leads to stability in terms of flows. These funds can be traded in the secondary market and may trade at a premium or discount. It is left up to the investors to invest based on their return expectations on the funds. The share price of the fund is determined according to the supply and demand.
According to data by Morningstar, the amount invested in an open-ended fund as of June 2018 was $289.5 billion. Amount invested in a close-ended fund was $27.37 billion and $13.44 billion in ETFs. The net assets as on June 2018 under open-ended fund were worth $1626.72 billion, $10 billion in closed-ended funds and $5.12 billion in ETFs.
Investors may prefer to invest in open-ended funds because they are actively managed. Fund managers have the flexibility to invest and trade in stocks based on their investment philosophy. One more advantage of an open-ended fund is that the past performance is easier to track as compared to a close-ended fund; especially for the close-ended fund which doesn’t get extended beyond their time frame.
According to AMFI, the total number of open-ended funds is 713, the number of close-ended funds is 1022 and 69 ETFs is there as of June 2018.
“An open-ended scheme is best suited for an investor who prefers more flexibility at managing investments. Close-ended funds, on the other hand, are suited to investors who want to park their funds for a set period and prefer to remain invested. ETFs are for investors who prefer to take a low-risk approach and would rather invest in the benchmark given its lower expenses,” says Kavitha Krishnan, Senior Research Analyst, Morningstar.
Expenses on close-ended fund tend to be lower as compared to open-ended funds given the longer investment horizon on the funds. Open-ended funds, on the other hand, have a relatively higher expense ratio, considering that they are more actively managed.
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Exchange traded funds also trade like stocks on an exchange, but the market prices are closely related to their net asset value than close-ended funds. The premiums and discounts of ETFs usually stay within 1 per cent of NAV. ETFs track the index they are benchmarked against.
Investors with a preference to invest in a passively-managed fund with a lower expense ratio prefer investing in ETFs. Traded on a continual basis, the fund manager has to replicate the benchmark in an ETF. This gives the investors greater flexibility to invest and/or redeem from an ETF. Because of these features, ETFs prove to be hugely beneficial to risk-averse investors.
“The allocation of funds amongst open-ended, close-ended and ETF is purely a function of risk appetite. In an alpha-generating geography like India, actively-managed funds tend to outperform ETFs over a longer period of time,” says Lakshmi Iyer, CIO and product head, Kotak Mutual Fund.
The bottom line is that open-ended products may be actively managed and are a safer choice than a closed-end fund, but close-ended products give better returns. However, the investor should always compare an individual product with an asset class. Some open-end funds can be riskier than some closed-end funds.