Avoid investing in mutual fund NFOs: Here’s why

invest-1A new mutual fund offering often attracts investor attention. At present, three new equity schemes—from Mirae Asset Mutual Fund, Principal Mutual Fund and ITI Mutual Fund—are open for subscription, apart from a debt fund from Indiabulls. After the new fund offer (NFO) window closes, these will be available for regular subscription as open-ended funds. Let us look at some of the points investors should consider before putting in money in the NFO phase.

Fund house track record 
Existing open-ended funds have several years of track record. One can analyse this return profile to gauge its worth. During the NFO phase, other than a broad idea about the scheme’s mandate, investors have little clue about what will constitute its portfolio or if it can execute the mandate. In the absence of a track record, investors have to rely on the fund house’s overall performance record.

In this regard, Mirae Asset MF ticks all the boxes. All three of its existing diversified equity schemes—Mirae Asset Emerging Bluechip, Mirae Asset India Equity and Mirae Asset Tax Saver—have an enviable track record, having consistently outperformed their benchmark and peers. They have the best risk-return profile in their respective categories. However, it has not executed a focused strategy before. Principal MF also has a decent track record in most schemes. ITI MF, on the other hand, is a new entrant and is yet to prove its credentials.

Suitability of mandate 
Any new scheme will spell out its mandate— how and where it will allocate its money. The new offering from Mirae Asset is the first time the fund house will run a scheme with a focussed portfolio. While it will take a multi-cap approach— investing across large, mid- and smallcap stocks—the concentrated exposure involves taking a different path. Its portfolio will only comprise up to 30 stocks at any time. Each bet will have a significant impact on overall returns from the scheme. The fund manager will have to adopt a selective stance, taking sizeable positions in most high conviction ideas.

If the bets play out as expected, this approach can yield high returns. If the calls go wrong, however, it can severely dent the fund’s return profile.

Principal Small Cap will invest a chunk of its portfolio in companies ranked beyond 250th in terms of market capitalisation. The small-cap segment is inherently risky, even if the potential for returns is very high over longer periods of time. Investors must ascertain if the scheme mandate suits their own risk profile and goals. Amol Joshi, Founder, Plan Rupee Investment Services, says, “Consider if the fund’s positioning fits in your own financial plan or asset allocation.”

These NFOs are currently open for subscription
In the absence of a track record, investors have to rely on the fund house’s overall performance.

Scheme nameCategoryNFO Closes on
Principal Small CapEquity: Small cap6-May
Mirae Asset FocusedEquity: Focused7-May
ITI Multi CapEquity: Multi cap9-May
Indiabulls Banking & PSU DebtDebt: Banking & PSU9-May

Timing of launch
An NFO is usually launched by a fund house to complete its product basket, or if there is a demand for a particular investment theme. AMCs tend to launch newer funds and come out with ideas when that theme is hot property in the market. Often, the funds are launched when the underlying theme is at its peak. If you invest at such a time, it may leave you with a sour taste. Try to ascertain the investment rationale for the theme and if it can hold sway over time. When investing in sectoral or thematic funds, investors must be mindful of the timing. NFOs of mid- and small-cap funds may yield varying results depending on the entry point.

During the NFO phase, the investor only has a rough idea about the maximum charges that will be levied by the scheme. The actual total expense ratio is disclosed only later. Newer funds initially charge a higher expense ratio as their corpus is very small. As its asset base expands, the costs start coming down. Investors should be mindful of the higher cost burden, says Rohit Shah, Founder & CEO, Getting You Rich.

Final word
It is advisable to go with existing schemes that come with an established track record than for a totally new offering. Financial planners say investors should invest in an NFO only if it has something different to offer, which cannot be achieved through an existing fund. “Consider the NFO only if it addresses a specific gap in your portfolio,” says Shah. Otherwise investors should wait for the fund to prove its credentials, says Joshi.

Avoid setting up a SIP during a fund’s NFO phase. Once you are convinced of the fund’s execution capabilities, only then should you initiate a long-term SIP in it. Remember, the NAV of the fund at time of investment has no bearing on the return you can expect. Low NAV during NFO does not mean it is cheaper. A quality fund is equally worth the bet whether its NAV is at Rs 10 or Rs 1,000.