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When should you invest in mutual fund NFOs?

NFO is often confused with IPO of a share where investors invest presuming they are buying cheap. The fund houses also do a great marketing job to sell their NFOs. Hence before investing, it is important to check if the NFO offered is offering some thing new or if something similar already exists with the Fund house.

November 29, 2012 / 03:56 PM IST

A mutual fund NFO or New Fund Offer is when a new mutual fund is launched and is offered to the public before it opens up to daily transactions.


To that extent it is similar to a share IPO where you buy the stock before it lists. A few years ago, share IPOs were offered at a discount to what people considered the fair value of the share, and invariably shares traded at a premium to their offer price on their listing. This generated quite a bit of excitement for IPOs and some of it got rubbed off to mutual fund NFOs as well. Mutual funds also do a great job marketing their NFOs and that creates a lot of interest whenever there is a mutual fund NFO.


However, very few mutual fund NFOs really merit the excitement they get. This is because there are largely two types of mutual funds - actively managed funds, and passively managed funds, and in most cases any new fund that's launched has a fund similar to it already available in the market.
In such a situation, it makes more sense to buy into a fund that's already available, has assets under management, and some track record to go by.


However, there are certain instances when you can seriously consider buying into mutual fund NFOs, and also subscribe to new ETFs (Exchange Traded Funds). ETFs are structurally different that mutual funds, but for the purpose of this post I will lump them with mutual funds, as both are similar in the context of a new fund offer.


Actively Managed Funds


Actively managed funds are funds where the fund managers try to beat the market by using a pre - defined strategy and the reality is that most active mutual funds are not able to beat their underlying indices.


In such a situation, how do you decide whether a new mutual fund will be able to beat its index or not? They tell you what they plan to do, and in many cases they back test their results as well, but if back testing were all there was to beat markets then every mutual fund would beat the market.


In the absence of any such parameters you have to largely rely on the prior performance of the fund manager and if that impresses you then that's a good reason to invest in this new NFO. However, that won't be the case for most NFOs.


Passively Managed Funds


Passively managed funds are funds that track an index or a commodity and just try to track the returns of that index or commodity. Gold ETFs, gold fund of funds and Nifty based mutual funds are a good example of passively managed funds. In the case of gold, there are 25 ETFs and fund of funds that track this commodity, so it's very hard for the 26th one to offer something new to investors and make them invest in it.


One exception to this is when the new fund promises to charge a lower expense ratio than the existing funds.


All funds charge its holders expenses, which are expressed as a percentage and the lower the percentage, the better it is for you.


If all existing gold funds charge expenses of 1% and a new fund comes in and charges just 0.25% then that's a good reason to consider buying into it.


However, the caveat here is that even with a lower expense ratio some funds don't do as well as funds with a higher expense ratio simply because of the tracking error that's caused by other reasons.


Exposure to a new commodity class


This is by far my favorite reason to invest in an NFO, but as is probably evident, it doesn't happen all that often.


When the then Benchmark (now Goldman Sachs) launched the first gold ETF, it was the only fund of its kind that was offering a way to get exposure to gold electronically in India, and that was a great reason to buy into that.


Similarly, Motilal's N100 ETF that gives you exposure to the NASDAQ was a great new product and for anyone interested, a very good reason to buy a fund during the initial days.


There is no ETF or mutual fund that allows you to get exposure to silver in India right now, but I'd imagine that such a product would generate a lot of interest during its launch as well, and rightly so.


Fixed Maturity Plans


This is a special class of mutual funds, which is close - ended and has certain tax advantages over fixed deposits and the only way to buy them is during the NFOs so it's a no brainer to buy FMPs during NFOs.


Conclusion

There is only so much money you can invest in mutual funds, and you should try to buy a few mutual funds with limited overlap so that it really gives you the benefit of diversification. With that in mind, evaluate each NFO carefully to see whether it's worthy of your portfolio or not.

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