Open-Ended Funds: Units Created and Cancelled on Demand

In an open-ended scheme a unit begins to exist the moment money is paid in, and stops existing the moment a holder is paid out. So the pool changes size continuously while the value of one unit does not. The party standing opposite the holder in that transaction is the scheme itself. An exit is met out of the scheme's own assets.

Most people meet this form before they meet the word for it. One person puts money into a scheme on a Tuesday, somebody else takes money out of the same scheme on a Wednesday, and neither of them ever hears about the other. The arrangement feels like a shop that is always open. Underneath, something more specific is happening. Almost everything believed about this kind of scheme turns out to be a consequence of one small mechanical fact rather than a separate feature, so the fact is worth naming precisely.

Girnar Asset Management Limited, an invented manager, operates one scheme throughout: the Girnar Large Cap Equity Fund, an open ended equity scheme carrying net assets of Rs 4,200 crore against 120.00 crore units in existence. Divide the first by the second and one unit stands at Rs 35.00 exactly. Kalyani Bhagat manages its portfolio and Sohail Merchant heads operations. Every figure attached to them is illustrative, and the custodian, the auditor, the trustee company, the registrar and transfer agent and the distributor appear by role alone.

Three things are settled elsewhere and carry into what follows. A unit, and how the value of one unit is arrived at, were settled when the pooled vehicle was introduced. A scheme, as a container holding a portfolio and keeping accounts of its own, was settled after that. Which party holds what, and the arrangement under which legal title sits with the trust through the trustee company while unit holders are the beneficial holders, was settled with the trustee. None of the three covered the one thing that follows: what happens to that container when people arrive and leave every working day.

Where do units come from, and where do they go?

Units are made and unmade. Making and unmaking is the whole definition, and every more comfortable one is worth resisting. A scheme is open-endedA scheme built so that units come into existence against money paid in, and are struck out of existence when a holder is paid out. when the number of units in it is not fixed in advance: money reaches the scheme and units are brought into being against that money, a holder leaves and the units they held stop existing. Nobody is holding a stock of units waiting for a customer. The units did not exist an hour before the money arrived, and the ones given up will not exist an hour after the holder is paid.

Two words carry the mechanism. CreationBringing a unit into existence on the scheme's record, against money the scheme has actually received. is what happens on the way in: the register of the scheme is written up, and the new units are added to the running count. CancellationStriking a unit out of existence on that record, with the pool paying the leaving holder what the unit was worth. is what happens on the way out: the register is written down, and the units disappear from the count. The running count itself has a name, units outstandingThe number of units in existence at the moment somebody counts them, which no scheme document fixes in advance for this form., and in this structure it is a number that moves every working day rather than a number set once.

Here is the part worth slowing down for. Everything associated with this form, the freedom to walk away at any time included, falls out of that one mechanism instead of being a separate feature bolted on. A holder can leave because there is a way to extinguish those units and pay for them; the scheme can accept a neighbour's money on the same afternoon because there is a way to bring new units into being. Nothing else had to be arranged. A canteen that cooks each plate to order does not need a queue of people waiting to buy back an uneaten plate, and it does not need to keep unsold plates on a shelf. The canteen cooks when an order arrives and stops cooking when the orders stop, and the number of plates in existence at any moment is simply the number people asked for.

When a holder leaves a scheme, who is on the other side?

The scheme. Not another investor, not the manager, and not a distributor sitting on a shelf of unsold units. Almost nobody asks who stands on the other side, and nearly everything else about the open form depends on the answer.

Consider what happens when almost anything else is sold. A flat, a motorcycle, a share on an exchange: somebody has to want it at the same moment the seller wants to be rid of it, at a number both can live with. The ability to get out depends on a stranger showing up. Put the same counterpartyWhoever stands opposite a party in a transaction and settles it with them, taking the other side of what that party is doing. question to an open-ended scheme, and the answer is different in kind. Nobody shows up. The holder asks to be paid out, the registrar and transfer agent writes those units off the register, and the money is sent from assets the scheme already holds. The units do not move to a new home; they stop existing.

An exit from an open pool cancels units instead of selling them, and that is precisely why leaving never waits on somebody else's appetite to buy. It also means the money has to come from somewhere real, and it does: the scheme's own assets. Legal title to those assets sits with the trust through the trustee company, and unit holders are the beneficial holders. The arrangement is covered separately. Only the direction of travel matters here. Money leaves the pool to reach the departing holder. No buyer routes it there, Girnar Asset Management Limited does not advance it out of its own resources, and whoever happens to be paying money in that day does not fund it. Money in and money out never meet each other. Each is recorded separately against the same pool, on the same register, on the same day.

There is an honest limit on that comfort. Being able to leave is not the same as being able to leave with a particular amount. Continuous dealing settles the route out, not the value that route pays: what a holder receives is whatever the computed value per unit turns out to be on the day the exit is struck, and that value moves with what the portfolio holds. Nor is the route itself absolute. Provisions exist under which a scheme may restrict payment on exits in stated circumstances; their triggers, their limits and the period for which any of them may run are set out in the scheme's own documents and in rules made by the Securities and Exchange Board of India (SEBI), and are read at sebi.gov.in and in the scheme documents on the day the question matters.

Why does one unit hold its value while the pool changes size?

Because both halves of the division move by the same proportion at the same moment, and a fraction whose top and bottom are scaled by the same factor is the same fraction. The proportional scaling is the entire answer, and it only convinces once it has been watched happening. It is worked twice below, in opposite directions.

Take the invented scheme at rest. Net assets are Rs 4,200 crore and units outstanding are 120.00 crore. One unit is Rs 4,200 crore divided by 120.00 crore, or Rs 35.00. Now Rs 350 crore of fresh money reaches the scheme and is allotted at exactly that value. How many units come into existence? Rs 350 crore divided by Rs 35.00 a unit is 10.00 crore units, exactly, with nothing left over. Net assets are now Rs 4,200 crore plus Rs 350 crore, or Rs 4,550 crore. Units outstanding are 120.00 crore plus 10.00 crore, or 130.00 crore. Divide again: Rs 4,550 crore over 130.00 crore units is Rs 35.00. The pool got exactly one twelfth larger, about 8.33 per cent, and one unit did not move by a single paisa. The fraction is exact and the percentage is not, because one twelfth does not land on a clean two decimal figure, and it is worth writing the exact form beside the convenient one rather than letting the convenient one pass as the truth.

Now push it the other way. People find that direction harder to trust. Holders ask to be paid out for 1.00 crore units. At Rs 35.00 a unit that is Rs 35 crore leaving the pool, and 1.00 crore units leaving the register. Net assets fall from Rs 4,550 crore to Rs 4,515 crore. Units outstanding fall from 130.00 crore to 129.00 crore. Rs 4,515 crore divided by 129.00 crore units is Rs 35.00 again. The money that walked out the door took exactly its own share of the pool with it and no more. Everybody else is left where they were.

Notice why the two answers agree. The two answers are not separate results that happened to match. Every transaction was struck at the same Rs 35.00, so the money added and the units added stand in that same ratio, and the pool and the count are both simply that ratio multiplied by a quantity that grew. One identity has been written twice, not a coincidence worth being impressed by, and saying so is more useful than acting surprised. Fairness across days rests entirely on that: an arrival pays the worth of a unit and a departure withdraws the worth of a unit, so neither one can reach into anyone else's share.

The round numbers used above deserve one warning. Rs 350 crore at Rs 35.00 gives 10.00 crore units with nothing left over, and that tidiness is a property of the figures chosen, not of the world. Where the pooled vehicle is introduced, a purchase of Rs 1,00,000/- at Rs 35.00 works out to 20,000 divided by 7 units. The honest answer is 2,857.142857 and it keeps going. The figure 2,857.143 sometimes written down is that number rounded to three decimals. At Rs 35.00 those 2,857.143 units come to Rs 1,00,000.005, five thousandths of a rupee away from what was paid. Nothing is wrong with the rounding; a register has to stop somewhere. The habit is worth naming: a chain that rounds in the middle and then announces an exact equality at the end is how a small error acquires a respectable appearance. In the arithmetic above the divisions close exactly, and they close exactly because the figures were chosen so that they would.

What do two days of flows look like, worked end to end?

The invented scheme runs through one day of money arriving and one day of holders leaving, and the arithmetic speaks for itself. Every division below is shown rather than announced, so it can be checked with a pen rather than taken on trust.

The last two rows read together give the shape of the whole structure. By the close of the second day the scheme was 7.5 per cent larger than at the start of the first, and across both days a single unit stood still to the paisa. Those two facts sit side by side without any tension between them, and a reader who can hold both at once has understood this form better than a reader who can recite the definition. The size of the pool is a fact about how many people were in it. The value per unit is a fact about what each share of it was worth. Size and value per unit answer different questions, and they are allowed to disagree about the direction of travel.

Now the part that matters more than the arithmetic, and the easiest thing here to get wrong. No return has been assumed anywhere in these two days. The Rs 35.00 held only because nothing inside the portfolio moved, and on any real working day it would move: prices change, income arrives, and the value per unit changes for those reasons rather than because of anybody's flows. The two days demonstrate something narrow and worth having on its own terms. Flows in and out, struck at the computed value, leave the value per unit alone. Everything else that happens to that number comes from what the scheme holds.

There is one more thing these two days did not settle. Handing over Rs 35 crore assumes the scheme can lay its hands on Rs 35 crore. The record in hand is silent about what, if anything, was sold to produce it, whether the scheme was already holding money it had not yet put to work, or whether Kalyani Bhagat had to touch the portfolio at all. The requirement stands even where the record does not answer it, and what it obliges the scheme to keep available is set out below.

What happens to the pool when the flow is pushed either way?

One control, three things that redraw, and one of them refuses to move. The control is the net flowMoney paid in less money paid out across a stretch of time, which may come out positive or negative. across a period: everything holders put in, less everything they took out. Dragged left, the scheme shrinks; dragged right, it grows. The marker on the bottom scale is the thing to watch while it moves.

Two details about the control are worth knowing beforehand. Each notch is Rs 7 crore, and that is not an arbitrary choice: Rs 7 crore divided by Rs 35.00 a unit is exactly 20,00,000 units, so every position on the slider lands on a whole number of units instead of a rounded one. And the travel stops at Rs 350 crore in either direction, one twelfth of the opening pool. The cap is illustrative and nothing more. No scheme is limited to taking in or paying out that much.

The thing worth noticing is that the marker is not being held in place by the code. The marker is recomputed from the two bars every time the control moves, so if the arithmetic were wrong it would wander off Rs 35.00 in plain view. The marker stays because Rs 4,200 crore plus seven notches and 120.00 crore units plus two tenths of a crore per notch are the same quantity written on two different scales. Every position on that slider is one identity written twice, so no position produces a different answer.

What does an exit oblige the scheme to be able to do?

Produce money. Producing money is the obligation the structure creates, and it is the price of the route out being always available. If exits were settled by a buyer, the scheme would need nothing at all; the buyer would bring the money. Because exits are met from the pool, the pool has to be capable of producing money on a day it did not choose, in an amount it did not choose, decided by people who never told it they were coming.

So an open-ended scheme has to keep some part of itself readily saleableAble to be turned into money quickly and near what it is worth, without having to accept a poor price to find a buyer.: holdings that can be turned into money without difficulty, or money already sitting in the scheme and not yet put to work. Keeping part of the pool readily saleable is a structural consequence of allowing continuous exit, and it exists whether or not any rule ever mentioned it. Precisely what a scheme must keep available for this, in what form and measured against what, is SEBI's to decide and is exact; it is read at sebi.gov.in. How the portfolio is chosen, weighted and rebalanced is a different subject, covered separately.

Whose decision sets how large the scheme becomes?

Not the manager's. Who does not decide the size is the structural point that most reshapes how the form is seen, and it arrives late because the way schemes get talked about suggests the reverse. A manager is written about as though the size of the scheme were an achievement or a decision. Size is neither. Kalyani Bhagat decides what the Girnar Large Cap Equity Fund holds; the people paying in and taking out decide how much of it there is.

Picture the working morning. She arrives to a pool whose size was settled overnight by several thousand people who did not consult each other, did not consult her, and mostly do not know each other exists. Some of them started a monthly instalment two years ago and have not thought about it since. Some paid a bonus in last week. Some needed money for a wedding and took it out. The net of all of that is a single number waiting on her desk, and her first task is to work with the pool she has been handed rather than the one she would have chosen.

Compare it with a shop that has to buy its stock. A shopkeeper decides how much rice to carry, and if they judge it badly the mistake is theirs. Now imagine a shop where customers keep depositing rice at the door overnight and taking rice away, and the shopkeeper's only job is to look after whatever quantity is there each morning. The judgement about quality is still entirely theirs. The judgement about quantity was never theirs at all. The second shop is the open pool, and the picture explains behaviour that looks strange from outside: money often arrives when prices have already risen and leaves when they have already fallen, and no manager chose either of those timings.

May a scheme close to new money and stay open-ended?

A scheme may do exactly that, and the surprise comes from the word sounding like a pledge about both directions. Open-ended is not a pledge at all. The word describes how units come into being and how they are extinguished, and a scheme can stop bringing new units into being while continuing to extinguish them for every holder who wants out.

The everyday version is a canteen at the end of a busy lunch. Somebody stands at the door and stops seating new customers. Nothing changes for anybody already inside: they finish, they pay, they leave whenever they like, and the room empties at whatever pace they choose. The kitchen has not changed what it is. The canteen has closed one door and left the other working exactly as before. The label attaches to the machinery for creating and extinguishing units rather than to any pledge about both doors staying wide. Shut the entrance, keep meeting exits, and the scheme is still open-ended.

Why would a scheme do it? The honest answer is that the reasons belong to the scheme's own circumstances and to rules made elsewhere. Structurally, entry and exit are separate doors with separate consequences, so it is possible to act on one without touching the other. When entry to a scheme may be restricted, and on what conditions, is SEBI's to decide, and sebi.gov.in carries the version in force.

Which day's computed value does a transaction get?

A rule settles it. Everything above has been struck at Rs 35.00 without once asking which day's Rs 35.00 that was, and on a working day that question has a precise answer. The name for it is the applicable valueThe particular day's computed value per unit at which a transaction is finally struck, once the rules deciding it have been applied., and getting it right is most of what a scheme's operations function does with a transaction.

Its shape in one sentence, with nothing in it that can go out of date: which day's computed value attaches to a purchase or an exit depends on when the instruction, and for a purchase the money itself, actually reach the scheme. SEBI writes that rule, sebi.gov.in carries it, and revisions happen there. This is the most examined mechanic in the whole subject, and the times, windows and thresholds attached to it are revised at their source: a fixed copy of a moving rule does not become gently dated, it becomes confidently wrong, which is worse.

Two things follow that are worth carrying away. The first is that the day an instruction is given and the day the transaction is struck are two different facts, and only one of them is settled by the person giving the instruction. The second is that a scheme's own documents may also attach an amount to an exit made soon after units were allotted. Whether one applies to a given scheme, at what rate and within what window, are the scheme's own stated terms, not an industry standard and not a regulatory limit. The terms are read in the scheme documents, and at sebi.gov.in for the rules those documents sit inside.

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