Mutual Funds help to grow money smartly. It is an investment tool where investors pool their funds. Later, the fund manager invests the funds across various securities as per the investor’s risk appetite and investment objective. In return, the investors receive their share of gains or losses in proportion to their investments. Mutual Funds help achieve financial goals and returns higher than the inflation rates. There are various types of mutual funds based on structure, asset class, benefits, etc. The article explains the types of mutual funds by structure.
Before jumping into the types of mutual funds based on structure, let’s understand the features of mutual funds.
Firstly, fund managers who have expertise in investing manage portfolios professionally. Secondly, mutual funds offer liquidity, allowing investors to buy and sell units easily. Thirdly, as per records, mutual funds deliver better returns than other investment options like bank deposits. Further, mutual fund investments are affordable as they require capital as low as ₹500 to begin. It also provides diversification benefits to the investors as fund managers invest in various asset classes and sectors. Hence, one gets a diversified portfolio with a small sum of investment. It reduces the risks involved. Lastly, SEBI (Securities and Exchange Board of India) regulates the working of mutual funds, which makes the entire process more transparent and protects investors’ interests.
There are three types of mutual funds by structure- open-ended funds, closed-ended funds, and interval funds. However, SEBI also classifies mutual funds based on different attributes like asset class, risk, etc. Types of mutual funds based on structure differentiate themselves based on flexibility in purchasing and selling units.
Open-Ended Funds are one of the types of mutual funds based on structure which does not have any time constraints regarding the trading of units. The investors can buy or sell a mutual fund unit at the current net asset value (NAV) at their convenience and time. Due to the trading, the NAV units fluctuate. The performance of securities covered under the mutual fund scheme determines the NAV. Moreover, there is no specific limit on the number of units one can issue. Also, they do not have any maturity period.
Open-Ended Funds have advantages and disadvantages. Firstly, an investor can purchase or redeem units on any working day, which increases liquidity. On the other hand, other investment options have a lock-in period which brings illiquidity. However, open-ended funds are highly liquid. Secondly, trading of these funds happens in the fund house. Hence, the investors can look at the past performances of the fund over different market conditions and make informed decisions before investing. Since the purchase of open-ended funds can happen on any working day, one can set up SIP (Systematic Investment Plan) to invest a fixed amount regularly. It helps salaried people have passive income.
However, it also has some drawbacks. Firstly, the NAV of the open-ended funds changes according to the underlying securities and market conditions. Hence, they are highly volatile, they carry a certain degree of risk even after diversification of investments. It is because diversified portfolios are open to market risks. Hence, due to the underlying benchmark, the NAV of the open-ended fund changes. Lastly, fund managers use their expertise and handle the portfolio, due to which investor does not get the opportunity to make decisions regarding the asset composition.
In closed-ended funds, the fund house determines the unit capital and issues a fixed number of units. The fund house cannot sell more than a specific limit of units. Moreover, there is a time restriction to buy the units. NFO (New Fund Offer) is like an IPO. Instead of companies, fund houses offer NFO to investors where they provide a deadline to buy mutual fund units. A fund house launches NFO when they want to set up a new fund scheme and raise money from the investors. NFO comes with specific fund size and a pre-defined maturity. One cannot purchase the units after maturity. Hence, they close after maturity and later get listed. Further, SEBI mandates the fund houses to give freedom to the investors to repurchase or exit from these schemes at NAV after maturity.
Closed-ended funds also have pros and cons. Firstly, closed-ended funds provide stability to the fund managers as the investors cannot redeem their units before maturity. Secondly, the closed-ended funds get listed after maturity. The demand and supply of the units determine their value. Hence, if the demand is more and supply is less, one can redeem their units at profits. Lastly, closed-ended funds might look illiquid, but fund houses’ website allow investors to trade these funds at existing market prices.
However, it also has some drawbacks. Firstly, they have underperformed in the past. Secondly, one needs to make a lump sum investment which increases risks. Lastly, in the case of closed-ended funds, the fund’s performance depends on the fund manager as there is no past data regarding the scheme.
Interval Funds are a perfect mixture of open-ended and closed-ended funds. They are open for purchase or redemption for a specific tenure and remain closed for the rest of the time. The fund house decides the period. Investors cannot trade units frequently. There is a maturity period before which one cannot sell their units. The fund houses may or may not list them on fund houses’ websites. Moreover, redemption is permissible at specific intervals (if listed). The fund manager utilizes the funds and allocates the assets in a security whose maturity matches the funds’.
They turn illiquid if not listed. Hence, even if the investor pays the exit load, he cannot redeem the units before maturity. Interval funds are best for investors who want to invest a lump sum amount of money for a specific tenure. Investors can match their time horizon with the maturity of interval funds to meet their financial goals. Moreover, interval funds are mostly found in the case of debt-oriented funds, suited for investors with low appetites. They provide lower returns than other types of mutual funds.