Mutual funds are diversified investment pools which are available to the general public, and are frequently used by investors to provide diversified exposure to securities as part of an overall asset allocation. They are registered securities and are highly regulated. They are frequently referred to as “investment companies”, and are structured in either an “open end ” or “closed end” format. We will review the basics of open end funds and closed end funds here, and discuss some of their advantages and disadvantages as relates to issues such as liquidity and valuation.
Open end funds
Open end funds are mutual funds which can be redeemed or purchased by an investor on a daily basis, and can be done so at the market price, or “net asset value”, of the securities which are held by the fund. The advantage of open end funds is that the investor does not run the risk of being unable to redeem his or her shares at the market price of the underlying securities in the fund. The main disadvantage of open end funds relates to the fact that assets flow in and out of the fund on a daily basis, the net result of which can be a negative impact on fund performance.
Closed end funds
Closed end mutual funds trade on a securities exchange, similar to a stock. The market price of the closed end fund will be determined by supply and demand of the fund on the exchange, and frequently will differ from the net asset value of the fund. A shrewd and disciplined investor can purchase such shares at a discount from their net asset value, and sell them at a premium to their net asset value. An advantage of closed end funds is that there are no daily inflows or outflows of fund assets, so the fund manager is able to manage the assets inside the funds in a long term manner.