What it means
The fund pools money from many investors and invests it in a portfolio of securities, such as shares or bonds. Investors own shares of the fund and can sell them back to the fund at any time.
Because the fund both creates and redeems shares, it is described as open-ended. The price at which investors buy or sell is based on the net asset value, or NAV, which is the total value of the fund's assets minus its liabilities, divided by the number of shares in issue.
It is normally calculated at the end of each trading day, and all purchases and redemptions that day use that price. This differs from a closed-end fund, whose shares trade on an exchange at a market price that can differ from NAV.
For investors the main attraction is liquidity and diversification. They can enter or leave without finding another buyer, and a small sum gives exposure to a wide range of investments.
For the management company, income comes from a management fee, usually charged as a percentage of the assets under management. The structure creates some practical issues.
If many investors redeem at once, the fund may have to sell holdings quickly, sometimes at unfavourable prices, which can affect the investors who remain. Funds therefore keep a cash buffer and may have rules for handling large redemptions.
Fees and expenses deserve attention. Besides the management fee, investors may pay administration costs, and some funds charge a sales commission or a fee when shares are sold, all of which reduce the return investors keep.
Regulation is significant. In many countries open-end funds are tightly regulated on disclosure, valuation, and limits on the types of assets held, to protect ordinary investors.
The details differ by jurisdiction, so the fund's prospectus is the best guide to its rules.
In practice
Real-world examples.
Example
An employee puts $500 a month into a bond mutual fund through a workplace savings plan. Each month the money buys new shares at that day's NAV, and the fund creates new shares to match the purchase. Her holding therefore grows steadily without her having to choose individual investments.
Example
A retired teacher sells shares in an equity fund to cover a house repair. The fund redeems the shares at the end of the day's NAV and pays the proceeds within the period set out in its rules.
Example
A fund manager sees heavy redemption requests during a market fall. She sells part of the portfolio and draws on the cash reserve to meet them, and she reports the larger outflow to the board. She also reviews whether the cash buffer is still the right size for the coming months.
Formula
Calculation
Net asset value per share = (total assets - total liabilities) / number of shares outstanding
An open-end fund holds assets worth $52,000,000 and has liabilities of $2,000,000, so net assets = 52,000,000 - 2,000,000 = $50,000,000. With 5,000,000 shares outstanding, NAV per share = 50,000,000 / 5,000,000 = $10.00. If an investor redeems 100,000 shares, the fund pays 100,000 x 10 = $1,000,000, and the shares outstanding fall to 4,900,000. The NAV per share stays at $10.00, because the redemption removes assets and shares in the same proportion.Case study
Seen in the real world.
Lakeshore Income Fund is a fictional open-end management company with $200,000,000 under management and a 0.75% annual management fee. The fee income was therefore 200,000,000 x 0.0075 = $1,500,000 a year.
After a period of poor market sentiment, investors redeemed $30,000,000, reducing the assets to $170,000,000 before accounting for performance. The management fee income fell to about 170,000,000 x 0.0075 = $1,275,000, and the manager had to cut costs.
The illustrative point is that an open-end structure ties the manager's income directly to investor flows, so keeping investors confident is a business priority as well as a duty. The finance team responded by testing how much cash the fund would need if a further $20,000,000 left over the next quarter, and it agreed a credit line with a bank as a backstop.
Watch out
Common mistakes.
- Assuming fund shares trade at a market price like a listed company, when open-end fund shares are bought and sold at NAV.
- Ignoring the fees, which reduce returns every year regardless of performance.
- Treating redemptions as risk-free for the fund, when large outflows can force the sale of holdings at poor prices.
Questions
People also ask.
What is the difference between open-end and closed-end funds?
An open-end fund issues and redeems shares at NAV on demand, whereas a closed-end fund issues a fixed number of shares that trade on an exchange.
Is every mutual fund an open-end company?
Most are, although the legal form differs between countries, and the fund's documents explain how it is organised.
When is the NAV calculated?
Usually once a day after the market closes, and orders placed that day are processed at that price.
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