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Don't succumb to the charm of New Fund Offers

NFOs may seem like a good investment option, but here is why you should go with an existing fund instead

Don't succumb to the charm of New Fund Offers

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Imagine that you are a selector of the Indian cricket team. You have an important decision to make. You have to select an opening batsman for the team and you have to pick one of two options in front of you. On one hand, you have an experienced batsman with a proven track record, and on the other hand you have a new batsman who has never played at the international level before. The new batsman has however received a lot of attention from the media and is hyped to be the next big thing. So who do you pick? Most of you would go with the experienced batsman and that would be the right decision.

Now imagine this scenario as a mutual fund investor. In place of the experienced batsman, you have a mutual fund with a proven track record. And in place of the new batsman, you have a New Fund Offer (NFO). As an investor, which of the two options would make more sense? The tried and tested mutual fund, of course. If an investor chooses an NFO, his investment call would be solely on the basis of the fund manager and/or the Asset Management Company (AMC).

Investors usually make the mistake of looking at an NFO in the same vein as stock initial public offers (IPOs). They tend to overlook the fundamental differences between the two. The price of a stock is based on the supply and demand for it, whereas the supply of a mutual fund unit is unlimited, and hence the demand for the fund's unit has no effect on the fund's NAV. IPOs often get listed at a premium because their demand exceeds their supply. But in the case of mutual funds, separate units are created when required for investment, and they cease to be at the time of redemption.

It is important for investors to understand that NFOs are merely marketing devices. AMCs use NFOs to create excitement and push their funds. Investors should just learn about the new fund on offer and invest later on when the fund is open for sale and repurchase on an ongoing basis. In the last decade, many new equity schemes have been launched through NFOs. These schemes are launched because they are easy avenues to capture management fees and increase the fund house's asset base.

A lot of specialised funds are also floated every now and then. These funds concentrate on particular trends, themes and sectors. There isn't much wrong with such specialised funds, but they take away the basic advantage of mutual fund investing. And that is to not have to decide which sector or theme to invest in. With a diversified equity fund, the fund manager decides where to invest. But when an investor invests in a specialised fund, this decision of choosing a sector or theme becomes his and hence, the risk factor increases.

However, coming back to NFOs, our take on them is the same for diversified funds as well as specialised funds. We have always believed that investors should stay away from NFOs, and we uphold our belief. There are a number of existing funds that have proved their mettle and we feel that investors should opt for them simply because they have a track record, whereas new funds don't. Sure, some new funds may turn out to be great and may outperform their categories just like a new batsman may score more runs than an experienced one. But then, investing isn't cricket. It has a higher risk factor and as far as the investor is concerned, there is much more at stake - the investor's hard-earned money. Hence, it pays to be a little bit more cautious.