Young Investor

Invest in NFOs with caution

BL RESEARCH BUREAU | Updated on October 15, 2011

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Have you been thrilled that you got rid of that pesky ‘timing' factor by investing in new fund offers (NFO) by mutual funds? Ever thought that it was easier to invest in an NFO than judge if a running fund is a good bet? The reality is, in fact, the exact opposite. Here's why.

Not cheap

Investing in NFOs requires a higher level of due diligence than investing in existing funds. Investors tend to buy units in new funds because they are allotted at a ‘cheap' Rs 10, by which they will get more number of units. According to their reasoning, this helps generate higher returns than an existing fund, which would have come with a higher NAV/unit tag. NAV is simply the net asset value per unit of the fund or, in other words, the market value of the portfolio divided by the number of units. Therefore, during NFOs, the fund house only pegs a new scheme's market value at Rs 10 per unit. What really should hold investment appeal is the potential of the underlying portfolio to deliver returns; the NAV is a mere reflection of performance.

Let's say you invested Rs 1,000 in two funds; Fund A with an NAV of Rs 100 and an NFO Fund B with an NAV of Rs 10. You will get 10 units of A and 100 units of B. If the underlying portfolio goes up by 20 per cent for both these funds, the Rs 1,000 invested becomes Rs 1,200 in each case. It doesn't really matter if fund A has an NAV of Rs 120, while fund B has an NAV of Rs 12 after the 20 per cent upswing. The returns you stand to make are the same.

Experience counts

So, it doesn't matter whether you buy a few units of an existing fund with a higher NAV or get more units in an NFO since no fund can be deemed cheaper than the other based on NAVs! But NFOs are to be treated with caution. Typically, they are launched during bull markets; sometimes a clutch of fund houses end up launching schemes simultaneously, adding to investor confusion. There have also been new fund houses jumping into the fray, with some not having long enough a track record in managing mutual funds. While some of the new fund houses make up for this by tying up with an overseas player, the fact remains that the new asset management companies (AMCs) are inexperienced — another potential risk to be considered is if the ‘investment talk' of new fund offers lures you.

Risks in an NFO

First, most NFOs launched require a lumpsum investment. This means that a larger amount is put to risk. The systematic investment plan is offered by very few of them, which, while subjecting the investment to the same risk, at least allows averaging costs over a fluctuating market cycle. Second, NFOs do not have a track record, which is the performance yardstick for existing funds. It is critical that you put your money in funds with an established track record. A fund's performance over one-, three-, and five-year periods needs to be considered before an investment decision is made, as over such a period only can the fund's ability to deliver superior returns over different market cycles comes to light. You could look at an NFO when you feel it offers something drastically new in terms of sectors and stocks it invests in or geographical exposure or investing strategy.

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Published on October 15, 2011

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