Why we should shun investing in Mutual Fund NFO?

Nowadays, many Mutual fund companies are floating new equity schemes with New Fund Offers(NFO) while taking the advantage of current ferocious market rallies. Since the mutual fund houses perceive that many investors have little sense to invest in ‘cheap’ NAV, initially priced at Rs 10. That’s crux of concept to lure the gullible investors investing in NFO at low value in higher valuation of the market. Every savvy investor should be wary about these types of seasonal launches. Since the initial NAV of the fund at time of investment does not carry any return as you may expect. Since low NAV during NFO does not mean it yields better returns than high NAV of  any existing mutual fund scheme. A quality fund is equally worth the bet whether its NAV is at Rs 10 or Rs 100. While investing in any mutual fund scheme, the factor of NAV is immaterialized as if you invested Rs 1,000 in an NFO, thus receiving 100 units. AfterÔ a month, the portfolio rose 10% and the NAV became Rs 11. Your investment will now be worth Rs 1100, or a 10% absolute gain. But say the NAV at the time of the NFO was fixed instead at Rs 100, giving you 10 units. The portfolio gain of 10% will take the NAV to Rs 110. Your investment is still worth Rs 1100. At the end of the day, it is the amount you are investing and how that investment grows that is important, and not the NAV. What you are buying is a mutual fund’s performance.

The Reason of Launch 

An NFO is generally launched by a fund house to complete its product basket, or if there is a demand for a particular investment theme. AMCs tend to launch newer funds and come out with ideas when that theme is hot property in the market. Often, the funds are launched when the underlying theme is at its peak.  If you remember to invest in equity mutual fund 6-8 years back, you would recollect the flavour of “natural resources” theme was promoted since it was a commodity boom across the globe. Similar phenomenon can be witnessed now as mutual fund houses are launching focused funds that target to keep portfolio brief and concentrated besides launching opportunities and Large and mid cap funds. If you invest at such a time, it may leave you with a sour taste. Get tried to ascertain the investment rationale for the theme and if it can hold sway over time. When investing in sectoral or thematic funds, investors must be mindful of the timing. NFOs of mid- and small-cap funds may yield varying results depending on the entry point. 

NFO equates with IPO

An NFO is, often compared with an IPO (Initial Public Offering). After all, it’s a new offering just like an IPO is. But there’s absolutely no similarity between them. In an IPO, a company is raising funds from the public that it will use for a specific purpose. An NFO is not a company. It is just pooling of money from investors and invests that in a set of securities based on a stated strategy.

Making informed decisions is possible in an IPO. An IPO’s prospectus contains extremely detailed information about the company’s financials, its business, its competition, its prospects, what the money is being raised for, what it will be used for and so on. You know the company’s business, its profitability, its growth over the years and whether the current offer price is justified.

Such informed decisions are totally absent in an NFO. At the time of NFO, the fund does not hold any stocks. The NFO scheme information document contains the strategy the fund will follow. Since the NFO has not any historical track record, one cannot expect and analyse the future return.  So investors and even financial advisors have little cue about the NFO how they will perform in future.  In the absence of a track record, one can rely on only the fund house’s overall performance record, which may or may not work. 

Higher Cost during NFO

During the NFO, the fund initially charge a higher expense ratio in compare with existing mutual fund scheme as it entails higher marketing and promotional expenses , management fee etc. which may dilute your initial return in first 1-3 years. Moreover, the actual total expense ratio is disclosed only later, which may be too much high or even slightly lower as it depends upon the size of corpus. 

The Higher Risk in NFO

While investing in an NFO, since, you are not buying a fund’s performance, you just buy the initial price of fund. That validation of a fund’s strategy comes about only it has seen a market cycle or two and you have the information to see how it navigates the markets and how successful it is in picking stocks. This is obviously not possible in an NFO since it has no track record. This makes NFOs a tricky investment vehicle. The risks you take in an NFO is much higher than when you go for a fund that has already been around for a few years and built up a history, even if both funds have similar market cap orientation, or similar duration or similar credit risk. Risks are greater when it’s a close-ended NFO as it does not give you the flexibility of an exit should the performance falter.

Conclusion 

It is, hence advisable to go with existing schemes that come with an established track record than for a totally new offering. We may invest in an NFO only if it has something different to offer, which cannot be achieved through an existing fund. If any NFO replicates the same strategy and fund allocation with existing one, there is no point to invest in NFO as your existing portfolio may get concentrated or under-performed. Hence, investors should look at other indicators, such as mandate of the fund, the fund’s past performance, how long the fund is in existence, size of the fund, the fund manager’s experience and history in managing the fund etc., before making final decision to buy a fund. So don’t fall trap in the low NAV or Rs10 NAV arguments, which prevails in NFO. 

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