What is an open-ended fund?
An open-ended fund is a diversified portfolio of investor mutual funds that can issue an unlimited number of shares. The fund sponsor sells shares directly to investors and also buys them back. These shares are valued daily based on their current net asset value (NAV). Some mutual funds, hedge funds, and exchange-traded funds (ETFs) are types of open funds.
These are more common than their counterpart, closed-end funds, and are the bulwark of investment options in company-sponsored pension plans, such as a 401 (k).
Key points to remember
- An open-ended fund is an investment vehicle that uses pooled assets, which allows for new contributions and continuous withdrawals from pool investors.
- Therefore, open funds have a theoretically unlimited number of potential shares outstanding.
- Some mutual funds and exchange-traded funds are the two types of open-ended funds.
- Variable capital shares are not traded on the stock market and are valued at the net asset value (NAV) of their portfolio at the end of each day.
Operation of an open-ended fund
An open-end fund issues shares as long as the buyers want. It is always open to investment, hence the name open-ended funds. The purchase of shares leads the fund to create new replacement shares, while the sale of shares puts them out of circulation. The shares are bought and sold on demand to their NAV. The daily basis of the net asset value is based on the value of the underlying securities of the fund and is calculated at the end of the trading day. If a large number of shares are redeemed, the fund may sell part of its investments to pay the selling investors.
An open-ended fund offers investors a simple, inexpensive way to pool money and buy a diversified portfolio reflecting a specific investment objective. The investment objectives include investing for growth or income, and in large and small cap companies, among others. In addition, the funds may target investments in specific industries or countries. Investors generally don’t need a lot of money to access an open-ended fund, which makes the fund easily accessible to all levels of investors.
Sometimes when the investment management of a fund determines that the total assets of a fund have become too large to effectively carry out its stated objective, the fund will be closed to new investors. In extreme cases, some funds will be closed to additional investments from existing shareholders.
Open-ended funds are so familiar – practically synonymous with mutual funds – that many investors may not realize that they are not the only type of fund in town. This type of investment fund is not even the original type of investment fund. Closed-end funds have been older than mutual funds for several decades, dating back to 1893, according to the Closed-End Fund Center.
The difference of closed-end funds
Closed-end funds are launched by an IPO and sold on the open market. The shares of the closed-end fund are traded on the stock market and are more liquid. They assess transactions with a discount or premium over the NAV based on supply and demand throughout the trading day.
Since closed-end funds do not have this requirement, they may invest in stocks, securities or illiquid markets such as real estate. Closed-end funds may impose additional costs through wide bid-ask spreads for illiquid funds and a volatile premium / discount on net asset value. Closed-end funds require that stocks be traded through a broker. Most of the time, investors can also receive the price of the intrinsic value of the underlying assets in the portfolio upon sale.
Advantages and disadvantages of open funds
Open and closed funds are managed by portfolio managers with the help of analysts. Both types of funds mitigate security risk by holding diversified investments and reducing investment and operating costs due to the pooling of investor funds.
An open-end fund has an unlimited number of shares issued by the fund and receives a net asset value at the end of the trading day. Investors trading on a business day must wait until trading ends to realize gains or losses on the open-ended fund.
In addition, open-end funds must maintain large cash reserves as part of their portfolios. They do this in case they have to comply with shareholder buyouts. Since these funds must be held in reserve and not invested, returns on open-ended funds are generally lower. Open funds generally offer more security, while closed funds often offer a better return.
Since management has to constantly adjust its holding to meet investor demand, the management fees for these funds are generally higher than those of other funds. Investors in open funds have more flexibility in buying and selling stocks, as the family of sponsorship funds always creates a market there.
Hold diversified portfolios, reducing risk
Offer professional money management
Are very liquid
Require low minimum investments
Are billed only once a day
Must maintain high liquidity reserves
Charge high fees and expenses (if actively managed)
Show lower returns (compared to closed funds)
Real example of an open-ended fund
The Fidelity Magellan Fund, one of the first open funds of the investment company, aimed at capital appreciation. It was founded in 1963, and in the late 1970s and 1980s it became a legend for regularly beating the stock market with its annual returns of 29%.
His portfolio manager, Peter Lynch, was close to a known name. The fund has become so popular, with assets reaching $ 100 billion US that in 1997, Fidelity closed the fund to new investors for almost a decade. It reopened in 2008.