How to choose a new fund offer (NFO)

Recently, the mutual fund street saw two big-ticket new fund offers (NFO) from two of India’s largest fund houses. It’s a good occasion to go through a check list on how to select a new fund. 

There are close to 2,000 mutual fund schemes in the market. Why, then, should you invest in a new one? The first thing you should check is if the scheme offers you something interesting and unique. After all, existing schemes are good enough to take care of most of your needs. Typically, it’s safer to go with existing schemes that come with an established track record than going with something that is totally new. 

Though NFOs are barred from charging NFO fees, they will still charge fees every year. Equity funds are mandated to charge a maximum of 2.5% of your weekly average net assets, every year; debt funds up to 2.25%; and index and ETFs up to 1.5%. The Securities and Exchange Board of India has also allowed fund houses to charge 30 basis points for going to ‘beyond top-15’ towns, subject to a certain amount coming from such places, and another 20 basis points in lieu of exit loads. One basis point is one-hundredth of a percentage point.

But the annual costs are supposed to come down as the fund’s size grows. Some fund houses voluntarily cut costs further, mainly due to competition. Check your NFO’s scheme information document to see if the fund house has a track record of bringing down expense ratios of other schemes. You might have to do a bit of hard work here and check with your adviser or distributor; or browse through past fact sheets if you want to invest directly with the fund house. See past few years' fact sheets to check the scheme’s expense ratio track record. 

All mutual funds are not taxed the same way. Debt funds impose a short-term capital gains tax at your income tax rates (10.3%, 20.6% or 30.9%) if you redeem the units before 3 years. After 3 years, long-term capital gains tax is applicable at 20.6%, with indexation benefits. Equity funds impose a short-term capital gains tax of 15% if you redeem units before a year. If you withdraw your equity mutual fund units after a year, there is no long-term capital gains tax to be paid. 

Although taxation should not be the primary reason for investing or avoiding a mutual fund, it pays to know your fund’s tax status, especially if your NFO aims to swing between equity and debt. 

Check if the scheme is open-ended or closed-end. A closed-end scheme comes with a fixed tenure and you would only be able to exit the fund after its tenure—typically 3-5 years, occasionally it could be 10 years—gets over. Such schemes are, however, mandatorily listed on the stock exchange. But you can only sell them if there is liquidity, else you have to take a hit on the market price, which could be at a significant discount to its prevailing net asset value. 

A lock-in is different. Open-ended funds like tax-saving schemes too have a lock-in. In the lock-in period, you cannot exit the scheme, even on the stock exchange.