Open-Ended vs Close-Ended: What a Fixed Unit Count Does

In one form the count of units rises and falls as holders arrive and leave; in the other it is settled at launch and stays there. Whether that count can move decides four things: who funds a departure, whether the pool is pushed into selling, whether the exit price is computed or agreed with a buyer, and what size the manager wakes up to.

Begin with something most people have lived through. A group of friends books a holiday, everybody puts money into one purse, and then one person drops out. There are two honest ways to settle it. The organiser can hand that person their share back out of the purse, in which case the purse is now smaller and somebody has to find the cash. Or the rule can be that the purse never shrinks: the person who is leaving must find somebody willing to take their seat, and whatever that replacement agrees to pay is what they walk away with. The two settlement rules are the whole of this guide, and everything a reader finds surprising about close-ended schemes falls out of the second one.

One scheme carries the arithmetic from end to end. Girnar Asset Management Limited runs the Girnar Large Cap Equity Fund, with net assets of Rs 4,200 crore and 120.00 crore units in issue. Divide the first by the second and one unit is worth Rs 35.00 exactly, a division this sequence has already worked and which is treated here as settled. Kalyani Bhagat manages the portfolio and Sohail Merchant heads operations.

Two things are settled elsewhere. The three forms set side by side and compared on four criteria are covered under the three-way comparison. The definition is borrowed here in a single line, and everything after it is given to the consequences. The close-ended structure taken apart in its own right is covered separately. Set against those, this guide puts the two forms head to head on the four things a holder actually feels.

What actually changes when the unit count is fixed?

Here is the one line, and it is the only definition borrowed. In an open-ended scheme the number of units in issue goes up when money arrives and comes down when a holder leaves. In a close-ended scheme the number settled at launch is the number that stays, whatever anybody does afterwards. Everything else in this guide is a consequence of that line, and not a single block below stands independently of it.

The difference is smaller than it sounds, and worth being precise about. Both forms are run by an asset manager. Both are held in trust for the people holding units, with legal title to the securities sitting away from the manager. Both value their holdings by a written policy. Both divide net assets by units in issue to reach a value per unit. The only thing that moves between them is whether the divisor in that last sentence is allowed to change when a holder acts. A fixed unit countA count of units that stays where it was put at launch, whatever holders do afterwards. is not an extra rule bolted onto a scheme; it is the removal of one, and four separate consequences fall out of that removal.

There are four blocks, each one tracing a single line of cause from the fixed count to something a holder can feel with their own money, and then a short block on what is unchanged, a worked exit run through both forms, and a trade that no structure settles on its own.

Whose money settles a departure in each form?

Somebody has to fund a departure, and the two forms reach into different pockets for it. In an open pool the scheme funds it out of itself. The departing holder's units go through cancellationStriking units off the register so that they stop existing, which is how an open pool settles with somebody who is leaving.. Assets worth the computed value of those units are handed over. In a fixed pool the scheme funds nothing at all. The departure never arrives at its door. The holder finds another investor, the units move from one name to another in a record kept elsewhere, and the money passes between those two people. The pool is not a party to any of it.

Return to the holiday purse. Leaving an open pool is like handing a ticket back to the organiser and being paid out of the common money; leaving a fixed pool is like selling that seat to somebody in the queue outside. In the first case the group is smaller and poorer by exactly one share. In the second the group is exactly as it was, and the only thing that changed is whose name is against the seat. The pocket that funds a departure is the first difference a holder actually meets, and it stays entirely invisible in either scheme's paperwork right up to the day somebody wants out.

Who stands on the other side of a transaction in an open pool, and how units come into being in the first place, were settled earlier in this sequence and are not rebuilt here. The comparison needs something narrower: in one form the counterparty to an exit is the scheme, and in the other it is a stranger the departing holder has to find. Nothing about either arrangement is hidden or unusual. The two arrangements are simply different answers to the same practical question, and a holder who does not know which answer applies to them will be surprised on exactly one day.

Must the pool sell something so a holder can go?

Money to pay a departing holder has to come from somewhere, and a portfolio of shares is not money. The gap between a portfolio and money carries the whole mechanism. An open pool that has agreed to settle with anyone who asks must produce rupees, and if it was not already holding rupees it has to turn something it holds into them. A fixed pool never faces the question. The departure was settled between two investors, and the pool was never asked for anything.

The part worth slowing down on is the date. When an open pool sells to fund a departure, the day of that sale was not chosen by Kalyani Bhagat. The date was chosen by whichever holder decided that was the morning they wanted their money. A sale made that way is a forced saleA sale made because money is needed, on a date that somebody else's decision to leave has chosen. in the plain sense of the phrase: not a sale under duress, just a sale whose timing was handed to the manager rather than picked by them. In one form the departures of other holders can push the manager into the market. In the other they never get near it.

The consequence has to be read carefully. An open pool is not thereby fragile, and a fixed pool is not thereby sturdy. An open pool can hold money precisely so that ordinary departures are settled without selling anything, and a manager who does that has removed the effect entirely for departures of ordinary size. The structure settles only one thing: the possibility exists in one form and is absent from the other. Whether it ever bites depends on how much money the pool keeps and how large the departures turn out to be.

Which process actually produces the price a leaver gets?

Price is the heart of the comparison and the part readers get wrong most often, so it is worth going slowly. The two forms do not merely pay different amounts. The two forms manufacture the amount by different processes, and those processes answer two different questions.

In an open pool the exit price is not agreed with anybody at all: it is computed. Net assets are divided by units in issue, and the answer to that division is the price at which the scheme settles with a departing holder on whichever valuation day the rules make applicable. Nobody bargains. Nobody quotes. The computed value per unitThe figure produced when net assets are divided by units in issue: an arithmetic result, not a price anybody quoted. is an arithmetic result produced by the scheme's own written valuation policy, and it lands wherever the arithmetic lands.

A fixed pool may have its units admitted to trading, and then the exit price is whatever a buyer is willing to hand over. The holder who wants out sells to that buyer and receives the transacted priceThe rupees a buyer actually handed over for a unit, which need not equal the arithmetic result the scheme published., and that transacted price can sit above the computed value per unit or below it. The scheme still publishes a computed value, exactly as before, worked out by the same division from the same valuation policy. But that computed figure is not what the departing holder was paid. The computed figure is what the arithmetic said a proportionate share of the pool was worth. The transacted price is what one specific person agreed to give up on one specific day.

Now the sentence readers find hardest, and it is worth reading twice. A transacted price sitting away from the computed value does not prove the valuation faulty. The two numbers are produced by different machinery. The computed value answers a question about the pool: what is in it, divided by the units in issue, gives a proportionate share. The transacted price answers a question about a negotiation: what did somebody, with their own reasons and their own urgency and their own view, actually agree to pay this morning? Two honest answers to two different questions are under no obligation to match, and a gap between them reports on the transaction rather than on the division.

Nobody can state the size or direction of such a gap in advance. The gap is settled each morning by whoever happens to be buying. What can be said is that the gap can exist in one form and cannot exist in the other, and the difference is structural rather than a claim about any market. The two prices below sit symmetrically on either side of the computed value, and neither direction is the usual one.

What does each structure hand the manager each morning?

Keep this block strictly structural. The question is the size of the pool a manager finds waiting in the morning, not what they ought to be holding inside it. Holdings are a different subject, covered separately.

In an open pool the manager does not get to set how big the pool is. Overnight, people who have never met Kalyani Bhagat put money in and take money out, and the figure she starts with is the figure their decisions produced. She did not choose it, she was not consulted about it, and on any given morning it can be larger or smaller than it was. In a fixed pool the size was settled when the pool opened and stays settled. Nobody's arrival adds to it and nobody's departure takes from it.

Think of two cooks. One runs a lunch counter and has no idea until people walk in whether they are feeding thirty or three hundred, so everything about how they work is shaped by not knowing. The other has been booked for a wedding with a settled headcount, and can plan around a number that will not move. Neither cook is better at cooking. The two structures do not hand the manager a different portfolio; they hand the manager a different degree of certainty about how much there is to run.

Stated plainly, this does not mean the open-pool manager is at anybody's mercy or that the fixed-pool manager has an easier job. The two managers are ready for different things. Their structures ask different things of them. The right holdings in response are a portfolio question, covered separately.

Can the two forms' results be set beside each other?

Carefully, and only after two labels have been fixed to every figure on both sides. A hurried comparison does real damage here, and it looks exactly like arithmetic the whole way through while quietly setting side by side two quantities that are not the same thing at all.

Start with what a scheme publishes. In either form, a scheme's stated return is a net returnA return figure that already has the scheme's running costs taken out of it, as opposed to one measured before them. worked out from values per unit: the running costs came out of the assets before the division was done, so nothing is deducted from the figure afterwards. Both forms state the figure that way. The convention holds without exception, and the word net travels with every scheme figure in this guide.

Now the fork. In an open pool, a holder who bought at the computed value and left at the computed value has a realised outcomeWhat a departing holder actually ended up with in rupees, once their exit was actually done. that is the same quantity the scheme published. Both ends of that holder's experience were struck at the computed value. In a fixed pool they are two different quantities. The scheme's figure still comes from values per unit. The holder's figure comes from what a buyer paid on the morning they sold. A scheme return describes the pool. In a fixed pool, what a holder actually walked away with describes one person and one transaction. The two may sit side by side, but they may never be subtracted from one another.

The discipline that prevents that error is small and mechanical. Before any two figures go side by side, write the basisWhether a figure is measured before or after costs, and over what stretch of time it was measured. and the period against each of them. Gross or net. Over what stretch. Describing the pool or describing a person. If the labels do not match on both sides, the subtraction is not available, and no amount of confidence about the arithmetic makes it available. The discipline is the one applied to gross and net figures everywhere else, extended to a second axis: not only what has been taken out of the figure, but whose figure it is.

What is exactly the same in both forms?

Almost everything stays exactly where it was. The parties are the same set of parties: an asset manager running the portfolio, a trustee company standing between the manager and the people holding units, a custodian holding the securities, a registrar and transfer agent keeping the records, an auditor auditing the accounts and, where one is involved, a distributor. None of them is named here, and none of them changes because the unit count is fixed.

The written investment policy is the same kind of document in both forms and binds the manager in the same way. The valuation is done by the same kind of policy, on the same holdings, producing a computed value per unit by the same division. And the beneficial claim on the assets is identical: the people holding units hold the economic interest in what the scheme has bought, with legal title sitting where the structure puts it, in both forms alike. One mechanism differs between the two forms, and that is the entire list.

The four blocks above therefore trace back to a single line rather than to four separate design decisions. Where the two forms are said to differ in six ways, the question to put is which of the six is not downstream of the unit count. Usually the honest answer is none of them.

What happens when one exit is run through both forms?

One holder, one exit, one set of opening figures, and two columns that are allowed to argue with each other. The second column is a labelled hypothetical: it takes the Girnar Large Cap Equity Fund's own numbers and asks what the same day would have looked like had that pool been a fixed one.

Both columns open at the same place: net assets of Rs 4,200 crore over 120.00 crore units. The division gives Rs 35.00 a unit exactly. The exit is 1.00 crore units. As a share of the units in issue that is exactly one one-hundred-and-twentieth. One one-hundred-and-twentieth is 0.8333 recurring per cent, and it rounds to 0.83 per cent. The percentage is a rounding and the fraction is not. Both are printed for that reason.

Column one, as an open pool. The 1.00 crore units go through cancellation, and Rs 35.00 a unit on 1.00 crore units means Rs 35 crore of assets walk out. Net assets fall to Rs 4,165 crore and units in issue fall to 119.00 crore. The holder received Rs 35 crore, the computed value to the rupee, and the scheme had to find that Rs 35 crore on a morning it did not pick.

Here is a check worth being honest about. Dividing Rs 4,165 crore by 119.00 crore units gives Rs 35.00, and it is tempting to call that a confirmation. The recomputation is not one. Taking away units at Rs 35.00 each removes exactly Rs 35.00 of assets for every unit removed. The division therefore returns Rs 35.00 for an exit of any size at all, and the recomputation is the first division rearranged rather than a second opinion. A check that cannot fail is not a check. So take a different road instead. Before the exit, the 119.00 crore units that were staying had a claim of 119.00 crore multiplied by Rs 35.00, or Rs 4,165 crore. After the exit, the pool holds Rs 4,165 crore. The second route starts from the remaining holders' claim rather than from the pool's own division, and it agrees. Agreement between two roads built differently is worth something.

Column two, as a fixed pool, and this column is a hypothetical run on identical opening figures. Nothing is cancelled. The pool remains Rs 4,200 crore against 120.00 crore units, and the value per unit computes to Rs 35.00 no matter what follows. The holder sells 1.00 crore units to another investor. Should that investor hand over Rs 33.00, the seller collects Rs 33 crore where the computed figure was Rs 35 crore, leaving Rs 2 crore on the table. Rs 2.00 measured against Rs 35.00 is exactly two thirty-fifths, being 5.714285 recurring per cent and rounding to 5.71 per cent. Not one rupee inside the pool shifted. Should the price be Rs 37.00 instead, the seller collects Rs 37 crore, ahead by that same two thirty-fifths, and once again nothing inside the pool moved.

Put the columns side by side now and name the exchange in a single sentence. The open pool settled the price for the holder and paid for that by having to produce Rs 35 crore on a day of somebody else's choosing. The fixed pool kept itself entirely out of the transaction and paid for that by leaving the holder's price to a stranger. Neither column contains a mistake. The two columns are arrangements, each doing exactly what its structure says it will do.

What is the trade here, and who gets to settle it?

Each structure gains one thing by surrendering another, and that is a genuine exchange rather than a flaw in either design. An open pool provides the route out itself, and the price on that route is computed rather than bargained. The pool pays for providing it with any freedom to disregard what other holders decide. Every departure arrives at its own door with a date attached. A fixed pool keeps departures away from itself entirely and is never put into the market by somebody else's decision. The holder pays for that in two ways: the route out is not the pool's to provide, and the price at the end of it is whatever a buyer agrees.

Read those two sentences again and notice that neither of them contains a winner. Continuous dealing settles the route out of a scheme. Dealing does not settle what that route pays, and a settled window is not protection either. The open pool's holder is certain of the mechanism and takes whatever the computed value happens to be that day, which can be lower than the day before for reasons that have nothing to do with them. The fixed pool's holder is not certain of the mechanism at all, and what they get depends on somebody they have never met.

Which side of that exchange suits a person depends on when they might need the money, what else they hold, how they behave when a number moves against them, and what they would actually do on a bad morning. Not one of those facts belongs to the structure. Resolving the trade takes those facts, and they belong to the person holding the units.

Kalyani Bhagat, Sohail Merchant, Girnar Asset Management Limited, the Girnar Broad Market Index Fund and the Girnar Large Cap Equity Fund are invented.
Educational material. Not advice on any investment, tax, budget or market position.