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Home / Mutual Funds / News /  5 Reasons to Say NO to an NFO

Since the beginning of the calendar year 2021, the Indian mutual fund industry has launched over 100 New Fund Offers.

They capitalised on the upbeat sentiments in the capital markets. These rollouts have been Multi-cap Funds, Flexi-cap Funds, Mid-cap Funds, Value Funds, Sector & Thematic Funds, Balanced Advantage Funds, Passive Funds (Index Funds and Exchange Traded Funds), international Fund of Funds (FoFs), and a few debt-oriented schemes.

More than 75,000 crore was garnered through various scheme launches, both active and passive. It appears that investors, perhaps perceiving NFOs to be cheap, have fallen for the 10 NFO proposition.

This is at a time when interest rates on traditional investments are low and inflation is playing a spoiler by eroding the purchasing power of money.

But, we believe there are some good reasons why you should say no to NFOs...

#1 Not all NFOs are unique

You see, after SEBI's categorisation and rationalisation guidelines for mutual fund schemes, most fund houses are trying to fill up the gaps in their product basket with NFOs.

In order words, they are simply trying to realign and re-bundle products without the underlying investment strategy and the portfolio being always unique.

With more schemes, the fund managers who are already managing 5-7 schemes (some with large AUM), are burdened further.

This also makes it difficult for them to own a unique underlying portfolio.

What changes to some extent is the composition of the respective security in the underlying portfolio.

Thus, when you are approaching NFOs, you need to study the fundamental attributes of the scheme, mainly the asset allocation, type of securities it will invest in, the fund's investment strategy, its investment objective, among other things.

Do not blindly subscribe to it just because the NFOs are offered at 10.

Consider if the scheme can really add value to your portfolio. If you already own some of the best mutual funds of the same category and sub-category, you don't need that NFO.

#2 Most NFOs are launched when market momentum is favourable

Have you seen fund houses launching schemes when the markets have corrected significantly? Not many, right?

This is a bit worrying because most fund houses launch their NFOs during the exuberant market phase. By then, it's likely the market rally has excited you, a fact mutual fund houses are aware of. Thus, they float NFOs during such times.

Besides, most investors usually tend to invest in market-linked instruments when the future looks bright, and not in a gloom-and-doom scenario.

As a result, NFOs do the rounds when markets have scaled new highs, valuations look stretched, and the margin of safety is narrow.

Thus, the respective fund manager's chance of getting good bargains while constructing the portfolio is limited.

To generate some quick profits, they subscribe to IPOs (or stand as anchor investors) to make listing gains. However, the risk is when these IPOs fail to post listing gains or the market falls.

Most often, the NAV of such funds also take a hit and falls below the offer price of 10.

So, do not get wooed with NFOs launched in an exciting phase of the market. Never make investments when your emotions are high and markets are scaling new highs.

Being wildly bullish can cost you dearly. History has proved that not all NFOs have been able to create wealth for investors.

#3 The cost of investing may be high

To manage every mutual fund scheme, a mutual fund house incurs sales & marketing expenses, administrative expenses, investment management fees, registrar fees, custodian fees, audit fees, etc.

All such costs are collectively included in the Total Expense Ratio (TER) of the scheme. This is levied as a percentage of the respective scheme's daily net assets. In other words, TER has a bearing on the scheme's Net Asset Value (NAV).

As per regulatory guidelines, the maximum TER an actively managed equity-oriented scheme and debt-oriented scheme can levy, is 2.25% and 2.00%, respectively.

On the other hand, for passively managed funds and close-ended funds, the TER is 1%. As the AUM of the respective scheme grows, a low TER is levied.

In addition, SEBI's regulations allow mutual fund houses to charge up to 30 basis points (bps) more if the new inflows come from retail investors from beyond the top-30 cities (B30) cities. This is done essentially to encourage inflows from the smaller tier 2 and tier 3 cities.

In the case of NFOs, initially, since the AUM size of the mutual fund scheme may be small, you could be bearing the higher TER. The fund house has the flexibility to do so as per the regulatory guidelines.

Remember, a high TER levied on the scheme could affect your overall returns, at least till the size of the scheme increases and it performs admirably.

#4 NFOs have no track record to rely on

An NFO does not have a performance track record and the only way to make an informed decision is from the information you have access to in the Scheme Information Document (SID).

This means you, the investor, have to thoroughly understand the investment objective of the scheme, its risk traits, the asset allocation, where it shall invest, the investment strategy to be followed, how it will benchmark its performance, and who will manage the scheme, among a host of other aspects, before you can subscribe to the NFO.

When you sift through most SIDs of a respective category and sub-category of mutual funds, you may find it challenging to differentiate the best one for your portfolio. In addition, you cannot merely count on the performance of other mutual fund schemes from the same fund house to make a judgement.

But when there is an assessable performance track record (of at least three years), making an appropriate choice becomes fairly easy.

If data of a longer period is available, you could even evaluate how the fund has fared across market phases (bull, bear, and consolidation) to check on the consistency with which the fund has delivered returns.

This makes it possible to gauge the scheme's returns vis-a-vis the level of risk taken. But in the case of NFOs, you do not have access to this vital quantitative data to make a prudent choice.

#5 You have existing mutual fund schemes to choose from

Relationship managers, mutual fund distributors, or investment advisors often insist that the NFO is great because it's an offering from a fund house with a large AUM and/or it will be managed by a star fund manager.

You should counter-argue that there are many other fund houses with smaller AUM and managed by relatively not-so-popular fund managers whose existing schemes look well poised to deliver stellar returns backed by their investment process and systems.

The existing mutual fund schemes that have completed three years and witnessed market phases could be a better choice. The fund manager may be holding a robust portfolio that has stood the test of time.

While past performance is not necessarily indicative of the future returns, it at least stands as testimony or indicates whether you should consider investing in the respective existing scheme or give it a miss.

When you are considering existing mutual fund schemes to add to your portfolio, evaluate them on the following parameters:

  • Returns over various time frames - 3-month, 6-month, 1-year, 2-year, 3-year, 5-year, 10-year, and since inception.
  • Performance across market phases (i.e. bull and bear phases) in case of equity-oriented schemes.
  • Performance across interest rate cycles (upward and downward) in the case of debt-oriented schemes.
  • Risk ratios (Standard Deviation, Sharpe, Sortino, etc.)
  • The AUM and expense ratio of the scheme.
  • Portfolio characteristics. In the case of equity funds, the top-10 holdings, top-5 sector exposure, how concentrated/diversified is the portfolio, the market capitalisation bias, the style of investing- value, growth, or blend - and the portfolio turnover. In the case of debt funds, the average maturity, modified duration, and the quality of debt papers.
  • The quality of the fund management team (experience of the fund manager, the number of schemes he/she manages, the track record of these schemes, the experience of the research team.
  • And the overall efficiency of the mutual fund house in managing the investors' hard-earned money i.e. the proportion of AUM actually performing.

If the investment strategy and calls taken by the fund manager prove right in times to come, it could potentially yield you respectable returns.

Final words...

Going forward, as mutual fund houses launch more schemes, do not make the mistake to add that new fund to your portfolio enthused by the 10 proposition unless it's absolutely unique and deserves taking some calculated risk.

Outsmart the opportunistic fund houses, their relationship managers, and mutual fund distributors/investment advisors. They consider you to be a fool and want to grow their business at your cost. Whatever is offered, whether it is an NFO, IPO, or investment advice, in the words of Euripides, 'Question everything'.

Diversify your portfolio intelligently by considering investments that are suitable to your risk profile, investment objective, your financial goals, and the time in hand before those envisioned financial goals befall.

Do not end up over-diversifying your portfolio. Over-diversification does not help create wealth beyond a point. All it does is make the portfolio look bulky, increases the burden of monitoring, and does not necessarily reduce your portfolio risk.

Last but not the least, whether it is mutual funds, stocks, bonds, or deposits, zero in on the best ones.

And once you invest, make it a point to review and monitor your portfolio. This will ensure you are on track to accomplish those envisioned financial goals.

Happy Investing!

This article has been authored by PersonalFN - a Mumbai based Financial Planning and Mutual Fund research firm known for offering unbiased and honest opinions on investing.

This article is syndicated from Equitymaster.com

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