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Open-end Mutual Funds

A mutual fund that issues shares to investors based on their net asset value (NAV) per share

What are Open-end Mutual Funds?

Open-end mutual funds refer to mutual funds that issue shares to investors based on the fund’s net asset value (NAV) per share. In an open-end mutual fund, investors purchase shares directly from the mutual fund at the net asset value (the value of the fund’s underlying securities) per share rather than from the existing shareholders.

 

Open-end Mutual Funds

 

 

Quick Summary:

  • In an open-end mutual fund, investors purchase shares directly from the mutual fund rather than from existing shareholders.
  • The share price paid for an open-end mutual fund – net asset value per share – is the per share price that new investors pay for a share in the mutual fund.
  • Open-end mutual funds must maintain a high cash reserve, which lowers the return of the mutual fund.

 

Breaking Down Open-end Mutual Funds

An open-end mutual fund is a collection of investor money pooled together to achieve a common investment objective. As the name implies, an open-end mutual fund is open to new investors. Investors who want to purchase shares of an open-end mutual fund would purchase it directly from the fund manager. It contrasts with closed-end mutual funds where investors purchase from existing shareholders.

The money pooled by investors is managed by a mutual fund manager who invests according to the mutual fund style. For example, assume three investors pool together $300 and are issued one share each. The $300 is managed by a fund manager who invests the money in securities. If the price of the securities doubles over the next year, the net asset value of the fund would be $600 ($300 x 2). With each investor holding one share, their per share price in the mutual fund would be $200 ($600 / 2).

 

Open-end Mutual Funds

 

Investors who are interested in joining the mutual fund can purchase shares directly from the fund manager at the net asset value per share of $200. Assume three new investors contribute $600 in total. The new net asset value would be $1,200 ($600 NAV + $600 contribution), and the shareholders would be issued 3 additional shares in the mutual fund. With six outstanding shares in the mutual fund, the net asset value per share remains $200 ($1200 / 6).

 

Open-end Mutual Funds - Sample Calculation

 

Understanding Net Asset Value

In an open-end mutual fund, investors purchase shares of the mutual fund at the net asset value. An understanding of net asset value is important when talking about open-end mutual funds.

The net asset value (NAV) is the net value of the mutual fund and is calculated as follows:

Net Asset Value = Total Value of Assets – Total Value of Liabilities

 

When potential investors purchase shares of an open-end mutual fund, the price paid is the net asset value divided by the number of shares currently outstanding:

Net Asset Value per Share = Net Asset Value / Shares Outstanding

 

Example

Mutual Fund A is an open-end fund with a net asset value of $1,000. Currently, there are 100 shares outstanding. John wants to purchase 100 shares of Mutual Fund A – what price does he pay? How does it affect existing shareholders of the mutual fund?

Given that the net asset value of the fund is $1,000, and there are 100 shares outstanding, the net asset value per share is $10 ($1,000/10). For John to purchase 100 shares of Mutual Fund A, the total price he pays is $1,000 ($10 x 100).

After the purchase of shares in Mutual Fund A, the net asset value is now $2,000 ($1,000 initial value and + $1,000 contribution from John). With a net asset value of $2,000 and 200 shares outstanding in Mutual Fund A, the shares of existing shareholders would be priced at $10. Existing shareholders are not affected by additional share purchases made by new investors.

 

Pros and Cons of Open-end Mutual Funds

Pros:

  • Mitigation of unsystematic risk due to the fund holding diversified securities
  • Managed by a portfolio manager with the help of analysts
  • Require low initial investment contributions
  • Highly liquid

 

Cons:

  • The net asset value per share is priced daily
  • The fund must maintain a high cash reserve due to the possibility of investors redeeming their shares
  • It charges management fees and expenses
  • Generally, they provide lower returns than a closed-end mutual fund (due to the cash held by the mutual fund and not invested)

 

Related Readings

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Fixed Income Securities
  • Hedge Fund
  • Investing: A Beginner’s Guide
  • Net Book Value

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