The MF industry is on an overdrive. The continuing bull market has energized the industry so much that we are being bombarded with NFOs day-in and day-out. The media blitz is simply overwhelming. Even if you try to evade a few, you are bound to be hit by the others. There seems to be no escape.

That’s trouble No.1 – the New Fund Offers.

An interesting aspect of the NFOs this time is that they are predominantly sector or theme specific. The current fancy is infrastructure, real-estate and global funds.

That’s trouble No.2 – the Sector/Thematic Funds

Why should one be skeptical about NFOs?

A lot has been said and written about NFOs. In fact, the situation had become so bad that SEBI had to come out with guidelines last year to curb the rampant misuse of NFOs.

Some of the disadvantages of an NFO are:

• There is no performance track record to assess. Essentially, you are betting on an unknown horse. So it is ‘betting’ not ‘investing’.
• There is no portfolio to judge. Suppose the portfolio finally turns out to be similar to some other fund that you already hold. Or it is too concentrated for your risk-appetite. Or the corpus collected is too large to be managed effectively. Or the corpus collected is too small to be diversified adequately.
• NFOs, especially the close-ended ones, are expensive at 6% costs vis-à-vis 2.25% entry load in an existing fund.
• You cannot do SIP in a close-ended NFO – a big drawback today as market valuations are not cheap.
• If you want to exit early, there would be high exit loads to pay. So reduced flexibility, with no commensurate benefit.

Therefore, unless the NFO has something compelling to offer which the existing funds don’t, it may well be prudent to give them a pass.

Then why do AMCs launch so many NFOs?

Well, the blame lies entirely on us – the investors. We simply cannot appreciate the fact that NAV of a MF has NOTHING, I repeat NOTHING, do to with its’ future performance. We are, therefore, ready to invest in an Rs.10 NAV fund, but would avoid investing in an Rs.100+ NAV fund.

What is wrong with theme-based funds?

Interestingly, one of the guidelines on NFOs was that an AMC cannot launch new funds which are similar to any of their existing schemes. Most AMCs already have the conventional diversified and mid-cap funds. Hence, this rush for sector/theme-based schemes! [By the way, some of the so-called theme-based funds are so broad-based that they mimic a diversified fund; the fancy-named NFO being just a marketing gimmick].

Prima facie theme-based funds are a great way to make big money. Actually, it is all human psychology – what we commonly term as ‘herd mentality’ or as some sophisticated people would say ‘momentum’.

But the problem is you don’t know when the fancy starts or when it ends. It could be months or it could be years. So you could either exit too early and miss the best part of the rally or exit too late when all the cream is gone.

Time and again, something or the other will catch the fancy of the market. And then everyone will rush headlong into it. Once upon a time it was Technology, Pharma or Auto. Today no one even talks about them. Now it’s infrastructure and real estate. Tomorrow, they too would be forgotten.

Moreover, theme-based funds defeat the three very basic ideas of investing in MFs – diversification, professional expertise and regular monitoring.

Firstly, we are concentrating our portfolio and thereby increasing the risk. MF was supposed to be a route to diversify our investment, not concentrate it.

Secondly, we are taking a call on the market as to which sectors will do well. We have entrusted our money to a professional fund manager. Don’t you think we should invest in a diversified fund vis-à-vis a sector fund and leave it to his expertise and experience to decide on the potential sectors (in fact, that’s precisely his job)? Are we smarter than the fund manager?

Thirdly, since we don’t know when the tide will turn, we need to constantly monitor a theme-based portfolio. Again, we had opted for MF, as we didn’t have much time to regularly monitor our investments.

Given all this, theme-based funds carry a higher risk than diversified funds.

However, if we can’t control our ‘gambling’ impulses, it would be prudent to invest only a small % of our corpus in such sector/theme-based funds.

So, be smart! Don’t be taken in by the media hype. Think twice – no, thrice – before your commit your money to theme-based NFOs.

- Sanjay Matai

The author is an investment advisor and can be reached at sanjay.matai@moneycontrol.com.

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