Why Investing in NFOs is not a good idea?
Whenever a fund house launches an NFO, there is a lot of buzz in the market. You see ads everywhere; there are fund manager interviews where they extol the virtues of the new fund’s investment strategy, you see newspapers carrying articles detailing what the new fund is, and a whole lot more.
With so much happening around you, it is quite natural to get carried away and invest. But is it a good idea to invest in an NFO? Before we get into this debate, let’s first understand what an NFO is?
So, what exactly are NFOs?
When an asset management company launches a new fund, it first opens it up for a subscription for select days. The aim is to raise money for buying stocks for the fund’s portfolio and get it off the ground. This entire process is called NFO or New Fund Offer.
In a lot of ways, it looks like an IPO, and that pushes people to buy in the NFO period. But there is no advantage like IPO. We will come to that later.
Now, as per regulation, in India, the NFO duration cannot be more than 15 days for any mutual fund.
After the NFO period, if the fund is open-ended, it starts accepting new investments within a few days. So, you can invest in a fund after the NFO period as well.
If it is a close-ended fund, then an investor can subscribe to the fund unit only during the NFO period and will have to hold it until the end of the duration.
Now you know what NFOs are, let’s look at reasons we believe you should avoid investing in them.
1) No Track Record
The fund being launched is new and therefore has no track record. In the absence of a history, people tend to rely on a fund house’s past performance, which might not be the best approach.
That’s because a new investing strategy comes with its challenges, and you don’t know whether the fund house has the expertise to overcome those challenges.
Also, you only know the broad mandate of the fund. You don’t know what will constitute the portfolio or if it will be able to execute its mandate as intended.
So, if a fund is being launched in a category where funds already exist, picking a fund with a track record makes a lot more sense. You will know what you are getting into as you can evaluate it on various parameters like past performance, risk it takes amongst other things.
Always pick a fund with history and a proven track record over a new fund.
2) NFOs are not like IPOs – There is no benefit of investing in the NFO period
As we said in the beginning, people look at NFOs as they look at IPOs. They think they will get benefitted if the demand for funds increases, just like it happens in stocks. This notion can’t be farther from the truth.
That’s because a mutual fund’s NAV doesn’t get affected by demand and supply.
Here’s why – the number of units available in case of a stock is limited, so their price goes up if there is more demand. On the contrary, there is no limit to how many units a mutual fund can have. Units get created as and when required.
3) Higher cost
Every fund charges a fee to manage your money. This fee is a percentage of the portfolio and gets deducted from the returns generated. In technical terms, it is called the expense ratio.
A higher expense ratio means you pay a higher fee and it affects the returns you get
As per regulations in India, a fund with a smaller Asset Under Management (AUM) can charge a higher expense ratio as compared to a fund with a higher AUM.
Now, since the fund size, when launched is small, the AMC has the flexibility to keep the expense ratio on the higher side.
4) Launch Timing
AMCs launch new funds because they want to complete or increase their product basket, other times it could be because there is a demand in the market for a particular kind of fund. The reason could be any.
So, just because a fund is launched doesn’t necessarily mean it is the right time to invest in that fund category. Especially if the trigger is market demand (you can figure it out by seeing how many similar funds have come in the recent past), it is best to stay away.
But there are a couple of exceptions though:
- If the NFO is for a close-ended fund and it fills a gap in your portfolio, you can consider investing. However, you need to be aware of the investing strategy the fund will follow as you will be committing for a specified duration.
- When you are getting a discount during the NFO, like the 5% discount Bharat CPSE ETF NFO offered, it might be worthwhile considering them. In the Bharat CPSE ETF, you knew in which companies’ money will get invested (as it is an index fund) and you got a discount as well.
Investing in NFOs is like a shot in the dark. It will be wise to opt for an existing scheme that has a proven track record instead of going for something new or unpredictable.
Even if it is something unique and can be a good fit in your portfolio, wait for some time to see if the theme or investment strategy plays out as intended.
Source: ET MONEY