Does opting for a new fund offer make sense?

Deepesh Bhatnagar, a 34-year-old owner of a garment store in New Delhi, delved into mutual funds after a partial lockdown was announced to contain the second covid wave. He started looking at new fund offers (NFOs) as he was under the impression that investing in them was cheaper and they could offer better value than existing funds.

Data from the Association of Mutual Funds in India showed that in the past seven years, mutual funds have launched over 2,200 new schemes in the country.

A fund house launches an NFO for multiple reasons. “They could be filling in a gap in one of the categories or they could launch a thematic fund when a particular sector or theme is doing well,” said Kavitha Krishnan, senior analyst - manager research, Morningstar India.

An NFO by an asset management company (AMC) is somewhat like an initial public offer (IPO) by a company. Under this, an AMC issues fresh fund units for investing based on a particular theme, which could be large-cap, mid-cap, international equities or even bonds.

At an NFO stage, a fund house hasn’t even built a portfolio of stocks or other instruments. At this point, a fund house simply collects the money.

Many investors prefer an NFO over existing funds as a new fund is available at the price of ₹10, which is its net asset value (NAV). However, experts say that this is a wrong strategy, which many investors, including Bhatnagar, are adopting.

“Investing in an NFO simply because it could earn a higher return could prove counterproductive to an investor’s portfolio,” Krishnan added.

We look at the factors that you should keep in mind when investing in NFOs.

According to experts, the main reason behind the demand for new funds is that most of the NFOs are sold and not bought.

“Most of the NFOs are pushed by agents, distributors or relationship managers because they are on commission. Anything that is marketed will have takers. Moreover, new investors who are not accustomed to mutual funds think that an NFO will offer them an attractive entry point, which is a fallacy,” said Vidya Bala, co-founder, Prime Investor. “There is nothing like a cheap NFO. An NAV is just a price allotted, so one should not be fooled into believing it is cheaper.”

Better returns are also not guaranteed in an NFO. The value of an NFO that is priced at ₹10 could go up by the same amount in percentage terms as compared to that of an existing fund.

This is essentially because the valuations are driven by the growth of the underlying assets on both the funds.

Moreover, experts believe that NFOs are usually costlier than existing funds.

“Launching a new fund incurs a lot of expenses. The fund house often invests heavily in promotion and marketing and these expenses are ultimately passed on to the end investor. It is also important to remember that funds that have a smaller AUM (assets under management) can charge higher expenses, keeping in line with regulatory norms. These factors could actually make a new fund more expensive as compared to an existing one,” said Krishnan.

As an investor, whether you need to put money in an NFO or not depends on the nature of the fund and if it is an existing category or a new theme.

Suresh Sadagopan, founder, Ladder7 Financial Advisories and a Sebi-registered investment adviser, believes that there is no sense in investing in NFOs.

“There are a lot of funds available in every category today. It is true that past track record cannot be extrapolated into the future, but at the same time, one cannot ignore the track record of the fund house and the manager,” Sadagopan said.

Over the past few years, the active investment segment has become jam-packed with most AMCs having multiple funds in almost all the categories.

Rushabh Desai, a Mumbai-based mutual fund distributor, suggests sticking with existing funds in the active segment if they are doing well. However, a case can be made for NFOs on the passive side.

“There are a lot of index funds that are coming up that are attractive. For example, Mirae came up with a FANG fund that was very unique, which appealed to investors who wanted to have exposure to global technology giants,” said Desai.

The Motilal Oswal Nasdaq 100 index NFO, which was launched in 2011, is another example as India didn’t have a US-based passive fund at that time.

Investors should look at how an NFO will fit into their portfolio, evaluate risks and compare its expenses with existing funds.

Moreover, investors should not invest in an NFO based on the assumption that a new fund will generate better returns.

“It is a misconception that all NFOs create better value than existing funds. A lot of investors invest because of the net asset value price; however, it doesn’t mean that it will give you double-digit CAGR (compounded annual growth rate) returns,” said Desai.

A theme might look attractive to investors, but they should wait for at least two to three years to understand how a new theme works or how it will perform in the market. Also, remember that if a fund is launched during market highs and there is a steep correction, investors will take a big hit in the fund.