Functional Classification of Mutual Funds
Functional classification of Mutual Funds is based on the basic characteristics of the mutual fund schemes for subscription. Mutual Funds on this account are classified into two broad types namely,
- Open-ended Mutual Fund.
- Close-ended Mutual Fund.
OPEN-ENDED MUTUAL FUND
The holders of the shares in the fund can resell them to the issuing mutual fund company at any time. They receive in turn the Net Assets Value (NAV) of the shares at the time of resale. Such mutual fund companies place their funds in the secondary securities market. Thus, they influence market price of corporate securities. Open-end investment companies can sell an unlimited number of shares and thus keep growing larger. An open-end mutual fund company buys or sells its own shares. Such companies sell new shares at NAV plus a loading or management fee and redeem shares at NAV. In other words, the target amount and the period both are indefinite in such funds. Unit Scheme, 1964, UTI's Magnum Multicap Fund, DWS Alpha Equity-G, FT India balanced, and Sahara Income Fund, Franklin India Blue chip Fund, are few examples. For open ended schemes, Mutual Fund Units are sold and bought at NAV with or without loading charges.
CLOSE-ENDED MUTUAL FUND
Close-ended Mutual Funds are different from the open-ended Mutual Funds in the following respects:
Close-ended fund investment company has a definite target amount for the funds and cannot sell more shares after its initial offering. Its growth in terms of number of shares is limited. Its shares are issued like any other company's new issues and quoted at the stock exchange.
The shares of close-ended funds are not redeemable at their NAV as are open-ended funds. On the other hand, these shares are traded in secondary market on stock exchanges at market prices that may be above or below their NAV.
Close-ended funds channelize funds in secondary market in acquisition of corporate securities.
The NAV and the price at which units of Mutual Funds are traded in the market need not always be equal: the units may sell for the current NAV per share, for more (at a premium), or for less (at a discount). Financial papers like The Economic Times and magazines like Business Today regularly report the NAVs of close-ended funds and present a comparison of the current price with the NAV. The reasons for the current market price being less than the NAV can be as follows:
- Investors' doubts about the abilities of the fund's management.
- Lack of sales effort (brokers earn less commission on close-ended schemes than on open-ended schemes).
- Riskiness of the fund.
- Lack of marketability of the fund's units.
The examples of close-ended Mutual Funds include: Canstock, Canshare Mastershare, Magnum, Can 80CC, Dhanashree, etc., which have the above features. It is to be noted that unlike in foreign countries where closed-ended and open-ended Mutual Funds are totally separate schemes, in India, this difference is not clearly demarcated. For example, UTI as Mutual Fund Manager has floated both close-ended schemes (Master share, Master plus, Growing Monthly Income Scheme '92 (GMIS '92,) etc.) and open-ended schemes.