What is an NFO and should you invest in them?
New Fund Offer or NFO as it is popularly known is doing rounds of late as more and more asset management companies are coming up with new funds. We, at WealthTrust, did extensive research to present you with our opinion on NFOs and should an investor be investing in them.
What is an NFO?
NFO, in simple terms, refers to a new mutual fund scheme offered by an asset management company (AMC). With capital markets touching new highs in past decade AMCs have tried to capitalize the market movement by launching a host of new schemes around different style, themes, structures and the likes. Back in 2004, monthly income plans captured the headlines; they were replaced by multi-cap funds in 2005. These were further replaced by tax-savings funds, small and mid-cap funds, thematic funds and many others over the years.
Should you invest in an NFO?
NFOs are generally launched at a time when market valuations are rich and investor sentiments are positive with indices inching up gradually. When investor sentiments are positive, it becomes easy for fund managers to attract investment in order to construct a portfolio. Also, AMC generally uses marketing tactics by way of offering lucrative incentives to distributors for pushing the NFOs through the door. We believe an NFO doesn’t have a track record to show, unlike an existing open-ended mutual fund. Thus, this could result in an investor entailing a higher risk for a return profile that is not worthy of the risk taken. An investor should ideally lay more emphasis on an existing fund to understand its investment style, process adherence, fund manager, fund manager’s experience and track record, underlying instruments’ and risk associated with each of these instruments. It is likely that an investor would generally conclude that an existing scheme is better off than NFOs.
Let us take a deep dive to understand reasons why an investor should ideally avoid an NFO and when he/she should actually invest through an NFO.
The Rs 10 attraction
Generally, NFOs have Net Asset Value (NAV) of Rs 10 offered to investors at the time of launch. This Rs 10 often becomes one of the driving factors behind investors’ seeking to invest. Investors generally try to draw a parallel between mutual fund units and stocks and consider Rs 10 to be an inexpensive and attractive investment. However, we believe, this approach could be fundamentally flawed. Let’s understand this point in greater detail with an example: In stocks, while there are book value and the market value representing stock’s intrinsic value and investor’s perception respectively, in case of mutual funds NAV represents total assets held by mutual fund after taking care of all expenses. A higher NAV represents nothing but total assets value in the fund. Thus, Rs 10 should not be misunderstood as weight market value of underlying securities.
AMCs generally offer similar funds as NFOs
AMCs generally don’t have anything completely new to offer. Typically what an AMC does is just re-bundle an existing scheme with different name and launch in the market as NFO. For example: In a diversified scheme the fund manager can invest in an attractive opportunity. Yet AMC launches products such as SMID cap, micro cap, multi-cap and the likes and if seen closely in most of the funds there’s a significant overlap of holdings. Thankfully the market regulator Securities and Exchange Board of India (SEBI) has put a full stop to such approach. They do not approve NFOs if they are identical to any existing fund offered by the same AMC. Even in a situation where an AMC tends to offer a new product, an investor should never invest in it blindly. We believe for a retail investor a plain vanilla diversified fund with a proven track record is ideal. A fund that has already seen the different business cycle, in our view, is best equipped to take advantage of any type of market. In a nutshell, at the end, it’s all about experience as it can trump everything else.
No track record
AMCs generally come up with their own logic, idea but we believe investing is a serious business and is not very easy. An investor has to have the patience to see true colours only after few years and it could be either success or failure. Thus, what is the point to go for something that can either succeed or fail with same probability when you already have an option to choose from existing funds that has proven its mettle? Investing in something that has proven record lowers the probability of failure.
NFOs are generally misunderstood as an IPO
Investors generally tend to look at NFOs as IPO. However, there is a difference between the two. A stock is typically based on demand-supply theory whereby if demand for a stock increases its price increases. On the flip side, mutual fund units can have an endless supply and are not impacted by demand. AMC typically create additional units as and when required depending on the demand.
Does NFO add value to your portfolio?
An investor should always question if an NFO adds value to his/her portfolio. They should ideally think if it could bring something that is not there in his/her portfolio. For example: if a sector presents an attractive opportunity for investment, fund manager of a diversified and existing fund would always tend to invest in such sectors. Then why is thematic NFO around that sector important? Thus, an investor should closely analyze the missing link between the existing fund and the NFO as the probability of new fund outperforming the existing funds always remains low.
After having covered the major shortcomings of an NFO and how an investor should ideally look at an NFO, we believe one of the most obvious questions which come to our mind is – Are all NFOs bad?
Well, the answer is a clear NO. We need to understand that every mutual fund was an NFO at some point. We believe before making any investment decision an investor should go through the NFO offer prospectus in detail to understand if the offer made by an AMC is logical enough for investing. We need to understand that only handful of NFOs become successful funds and provide healthy returns over its benchmark.
An investor should always be rational and avoid making any commitments when his/her emotions are high. It goes on without saying that a rising market excites every investor and they all seek to ride with the market. But this upward trend is not here for an indefinite period and this is what an investor should look at. It is often seen that an unseasoned investor commit big-ticket fresh investment in order to ride through market but they generally do not decide what is appropriate for their financial future and the investment goes for a toss.
To conclude, for retail investors, investing in NFO could be similar to shooting in dark. It is always advisable to invest in something that has a better probability of performing well. It is undoubtedly true that an NFO can be extremely successful for their unique idea, investing style but it is always a tough call to successfully choose them. Thus, it is always wise to avoid them.
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