Open-Ended Vs Closed-Ended Funds
Open-Ended funds and closed-ended funds can be regarded as two main collective investment instruments. Open-Ended funds (OEFs) are funds which stay open; there is no fixed number of shares and are usually not traded on exchanges (eg: mutual funds). Closed-Ended funds (CEFs) have fixed number of shares and are traded through exchanges just like stocks. Here are the key differences between open-ended and closed-ended funds.
- Whenever an investor buys shares of open-ended funds the funds asset rise as money is added (equal to the price of shares) to the asset pool, and whenever an investor liquidates shares the funds asset decline as money is taken from the pool of assets. But in closed end funds as buying and selling activities not directly affect funds asset.
- The value of open-ended funds is equal to their Net Asset Value (NAV). But value of closed-ended funds can deviate from NAV. Positive deviation is named as premium and negative deviation as discount.
- The expense ratio of open-ended funds is often higher than closed-ended funds. This is because CEFs do not have to deal with regular creation and redemption of shares.
- As closed ended funds are traded on exchanges, they are bound to obey some rules which make them more transparent to investors, especially to its shareholders.
- Because of their low expense ratio, CEFs are allowed to invest more in illiquid securities than OEFs.
- For creating and redeeming shares, open-ended funds are forced to keep some part of their asset as money, where as closed-ended funds can invest all (most) of their asset to build a portfolio of stocks or other securities.
- In periods of market panic, for rising money in hand, open-ended fund managers can be forced to sell some asset of their portfolio which they want to hold and this can harm the liquidity and balance of the fund. This is not a problem with closed-ended funds as buying and selling activities are between market participants (investors, brokers and market makers) and the fund is not directly involved in it.