Don't get fooled by new funds

A lot of mutual fund investors, for some illogical reason, have developed a special liking for New Fund Offerings of mutual funds.

Some have a tendency to invest in every NFO that comes their way, irrespective of what they offer.

The common perception is that investing in a NFO at par value (Rs 10 per unit) is the best deal and you substantially improve your chances of getting a better return.

Let's debunk this myth by first understanding what a NFO is.

Open-ended fund

An open-ended fund means that you can buy and sell the units from the mutual fund house anytime.

 The NFO for such funds marks the beginning of a scheme where the units are sold at par value.

Some funds may charge an entry load during this period while others may refrain from doing so.

Once the scheme reopens for on-going sales (when you buy the units) and redemptions (when you sell the units back to the asset management company), the Net Asset Value is announced on a daily basis.

This means you can buy and sell the units directly from the mutual fund at NAV-based prices. The NAV reflects the actual value of the assets (investments) in the scheme minus the expenses of the scheme.

Close ended fund

For a closed ended scheme, the NFO is an important event.

Investors can buy units of such a scheme directly from the mutual fund only during this period. Anyone who wishes to buy units after the closure of the NFO can do so only from the secondary market (stock market) at market determined prices.

The misconception

Many investors believe that investing in an existing scheme at a higher NAV is riskier than investing in a NFO.

"Why pay Rs 20 for one unit of an existing fund when you can get it for Rs 10 in a NFO?" is what they believe.

Little wonder then that almost every NFO attracts a large number of investors, while some existing schemes with consistent and impressive track records struggle to attract new money.

It is a completely wrong notion on the part of investors.

Let us understand it with the help of an example.

Let's say there are two investors: Ajit and Ram.

Ajit invests Rs 10,000 in a NFO at Rs 10 per unit.

Ram invests Rs 10,000 in an existing fund at a purchase price of Rs 40 per unit.

Ajit will get 1,000 units but Ram will get only 250.

Now, let's assume the NAV goes up by 10% in both the cases.

This means that the NAV of the NFO will be Rs 11 (10% appreciation of Rs 10) and of the existing scheme will be Rs 44 (10% appreciation of Rs 40).

The current value of both Ram and Ajit's investments would be Rs 11,000; Ram's 250 units have the same value as Ajit's 1,000 units. Ram also has the advantage of having invested in a fund that has some years of experience.

In no case is Ajit better off than Ram just because he invested in an NFO.

What matters

It is important to understand that, in the long run, the growth in the NAV will depend on the quality of the portfolio, the fund's exposure to various industries and segments of the market as well as the strategy of the fund manager.

Simply put, it will depend on where the fund manager has invested. If it is equity, it would depend on the type of stocks he has invested in -- whether large cap, mid cap or small cap. If it is debt (fixed return) instruments, then it would depend on the type of instruments and their maturity.

Therefore, the belief that investing in a NFO guarantees success is completely unfounded. Besides, if one doesn't analyse the features of the scheme, one may end up having over-exposure in a particular asset class or segment.

Let's say a new tech fund is launched and you invest in it. If you already have invested in shares of infotech companies and the portfolios of your current mutual fund investments have a fair number of infotech shares, you are now going to be heavily invested in the tech sector. And this may not be what you want.

NFO or not?

However, this does not mean one should not invest in a NFO.

If a scheme has some compelling features like investing in a particular segment of the market on which you are bullish, it may be a good investment.

Or the NFO may invest in instruments one can't directly invest in due to lack of knowledge or because the minimum amount required to participate in them is much higher than one can afford to invest.

In such cases, investing in an NFO helps improve the returns on your existing portfolio and it definitely makes sense to consider it.

In other words, invest in an NFOs only to fill the gap in your portfolio or widen your investment universe.

Remember, a mutual fund launches new schemes to complete its range of products to suit the requirements of investors with different profiles and investment horizons. Therefore, every new mutual fund may not suit your requirements. You need to analyse the features properly and then take a decision to invest or not.

The author is CEO, Wiseinvest Advisors Pvt. Ltd, a mutual fund advisory firm.