There are three primary structures of mutual funds: open-end funds, unit investment trusts, and closed-end funds. Exchange-traded funds (ETFs) are open-end funds or unit investment trusts that trade on an exchange.
Open-end funds
Open-end mutual funds must be willing to buy back (“redeem”) their shares from their investors at the net asset value (NAV) computed that day based upon the prices of the securities owned by the fund.
Most open-end funds also sell shares to the public every business day; these shares are priced at NAV. Most mutual funds are open-end funds.
Closed-end funds
Closed-end funds generally issue shares to the public only once, when they are created through an initial public offering. Their shares are then listed for trading on a stock exchange. Investors who want to sell their shares must sell their shares to another investor in the market; they cannot sell their shares back to the fund. The price that investors receive for their shares may be significantly different from NAV; it may be at a “premium” to NAV (i.e., higher than NAV) or, more commonly, at a “discount” to NAV (i.e., lower than NAV).
Unit investment trusts
Unit investment trusts (UITs) are issued to the public only once, when they are created. UITs generally have a limited life span, established at creation. Investors can redeem shares directly with the fund at any time (similar to an open-end fund) or wait to redeem them upon the trust’s termination. Less commonly, they can sell their shares in the open market.
Unlike other types of mutual funds, unit investment trusts do not have a professional investment manager. Their portfolio of securities is established at the creation of the UIT.
Exchange-traded funds
Exchange-traded funds (ETFs) are structured as open-end investment companies or UITs. ETFs combine characteristics of both closed-end funds and open-end funds. ETFs are traded throughout the day on a stock exchange. An arbitrage mechanism is used to keep the trading price close to net asset value of the ETF holdings.