Classification of Mutual Funds By the structure of the fund
- M Manohar Rao
- Jul 16
- 6 min read
Tags: Wealth Management, Investment Lesson, Mutual Funds, Mutual Fund Basics, Stock market, Budget, Finance, Investing, Personal Finance, Investment, ETFs, SIP, Multi cap
Mutual fund schemes are structured differently. Some schemes are open for purchase and repurchase on a perpetual basis. Once the scheme is launched, the scheme remains open for transactions, and hence the name of this category of schemes is open-ended funds. On the other hand, some schemes have a fixed maturity date. This means that these schemes are structured to operate for a fixed period till the maturity date and cease to exist thereafter. Since the closure of the scheme is pre-decided, such schemes are known as close-ended schemes. .
Open-ended funds
allow the investors to enter or exit at any time, after the NFO7. Investors can buy additional units in the scheme any time after the scheme opens for ongoing transactions. Prospective investors can also buy units. At any time, the existing investors can redeem their investments, that is, they can sell the units back to the scheme to get their money back.
Although some unit-holders may exit from the scheme, wholly or partly, the scheme continues operations with the remaining investors. The scheme does not have any kind of time frame in which it is to be closed. The ongoing entry and exit of investors imply that the unit capital in an open-ended fund would keep changing on a regular basis.
When an investor invests money in the scheme, new units would be created and thus the unit balance would increase. On the other hand, when someone exits the scheme (fully or partly), the units sold back to the scheme would be cancelled, due to which the unit balance of the scheme would go down.
Close-ended funds
have a fixed maturity. Investors can buy units of a close-ended scheme, from the fund, only during its NFO. The investors cannot transact with the fund after the NFO is over. At the end of the maturity period, the scheme is wound up, units are cancelled and the money is returned to the investors. The fund makes arrangements for providing liquidity, post-NFO through listing of the units on a stock exchange. Such listing is compulsory for close- ended schemes to provide liquidity to the investors. Therefore, after the NFO, investors who want to buy units will have to find a seller for those units in the stock exchange. Similarly, investors who want to sell units will have to find a buyer for those units in the stock exchange. Since post-NFO sale and purchase of units happen to or from counter-party in the stock exchange–and not to or from the scheme–the unit capital of the scheme remains stable or fixed. Every close ended scheme, other than an equity linked savings scheme, shall be listed on a recognised stock exchange within such time period and subject to such conditions as specified by SEBI.
Post-NFO, the sale and purchase transactions happen on the stock exchange between two different investors, and the fund is not involved in the transaction. Depending on the demand- supply situation for the units of the scheme on the stock exchange, the transaction price could be higher or lower than the prevailing NAV. Therefore, the transaction price is likely to be different from the NAV. Experience suggests that most of the time, the units trade at a discount to the NAV. This can be understood logically. The buyer has money, and hence many options to choose from, whereas the seller has the units of the close-ended fund. This puts the buyer in a better bargaining position.
Interval funds
combine features of both open-ended and close-ended schemes. They are largely close-ended but become open-ended at pre-specified intervals. For instance, an interval scheme might become open-ended between January 1 to 5, and July 1 to 5, each year. The benefit for investors is that, unlike in a purely close-ended scheme, they are not completely dependent on the stock exchange to be able to buy or sell units of the interval fund. However, to provide liquidity to the investors between these intervals, the units must be compulsorily listed on stock exchanges to allow investors an exit route.
The periods when an interval scheme becomes open-ended, are called ‘transaction periods’; the period between the close of a transaction period, and the opening of the next transaction period is called the ‘interval period’. Minimum duration of the transaction period is 2 days, and maximum duration of the interval period is 15 days. No redemption/repurchase of units is allowed except during the specified transaction period (during which both subscription and redemption may be made to and from the scheme).
(Note: The provision to list the units on a recognized stock exchange would apply to Specialized Investment Funds, as well, if the specific investment strategies are launched as close-ended or interval structures).
While the units of close-ended and interval funds are listed on the stock exchanges, the liquidity in these units may be poor. At the same time, even when the trade happens, the actual price may be at a discount to the NAV. This happens because of the demand-supply situation for the units of the schemes, as discussed earlier.
The Exchange Traded Funds (ETFs)
are an innovation that addresses this liquidity issue. The market price also tracks the NAV very closely.
Exchange Traded Funds (ETFs) are those mutual fund schemes that are traded on a stock exchange just like any other stock. These funds usually track an index or have a fixed portfolio strategy based on some index so they are passive in nature. In effect they are like a normal mutual fund but the only difference being that while an open-ended fund would have a single NAV at the end of the day at which all the transactions take place the situation is different for the ETF. Since the ETF is traded for the entire day, it gives multiple opportunities and prices at which the investor can either enter or exit the fund. This is similar to any other listed securities where there are multiple prices at which transactions take place and this is witnessed for an ETF too. ETFs provide additional liquidity for investors and enable them to take benefit of changes that take place in prices during the day. The downside to this is that the prices might fluctuate quite a bit and there might be a big gap with the NAV of the fund too. So, investors need to be careful about the price at which they are undertaking their transactions. There is ease of investing in an ETF because one can buy them just like a stock and the minimum investment here is also so small that any investor can participate by having these in their portfolio. Investors who already transact on the stock exchanges and have a demat account can use these for investing in ETFs. There is a huge variety in terms of the indices on which ETFs are based and hence this provides investors with a lot of choice in terms of their investments and the kind of exposure that they can take. Increasingly mutual funds are also coming out with different variants that employ varying strategies for their ETF offerings. Like Gold ETF recently Silver ETF has also been introduced by SEBI that can be defined as a mutual fund scheme that invests primarily in silver or silver related instruments which are specified by SEBI from time to time.
Disclaimer:
The information set out above is included for general information purposes only and is not exhaustive and does not constitute legal or tax advice. All complaints regarding Mutual Fund can be directed towards visit www.scores.gov.in (SEBI SCORES portal). Readers are requested to make informed investment decisions and consult Chaitanya Financial Consultants – 9000628943 / mfd.mmr@gmail.com to determine the financial implications with respect to investing in Mutual Funds.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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