What to check before investing in new fund offerings :: Business Line

Here is food for thought. What factors should you consider when you invest in a new fund offering (NFO)? We ask this question because many of you continue to use the price rule — investing in a new fund because the net asset value (NAV) is Rs 10 a unit against comparable existing funds that may have higher NAV. In this article, we discuss whether you should invest in an NFO and, if so, the factors that you should consider.

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CASE AGAINST NFOS

Most of us prefer products that have an established track record. But choosing an investment product based only on an asset management firm or a fund manager’s track record may not be optimal. Why?

An asset management fund that manages a large-cap fund may now launch a mid-cap fund. You will agree that selecting mid-cap stocks is not the same as selecting large-cap stocks. So, even if the fund manager is successful in managing the large-cap fund, she need not be just as efficient with the newly-launched mid-cap fund.

And that is not all. You may have read the statutory warning carried on all mutual fund documents — past performance is not an indicator for the future. That means even fund managers with the most successful track record are unlikely to sustain their performance in the future. Suffice it to know that research has shown that this is, indeed, true.

This second argument points to a rather irrational conclusion: Track record is the primary information you have to decide whether to invest in a fund. And yet, track record cannot help you determine whether existing funds can outperform their benchmark in the future. So, how will you analyse NFOs, which do not have a track record yet? This means you should not invest in an NFO. But you will do yourself a disservice if you ignore NFOs. So, how should you invest in NFOs?

CASE FOR NFOS

The above argument is true for active funds (funds that have a mandate to beat their benchmark). Suppose an asset management firm launches an index fund on a benchmark on which there are no competing products. If the benchmark helps you meet your investment objectives, you should invest in the NFO. Recently, a financial institution launched an index fund this year benchmarked to the CNX Dividend Opportunities Index. You would have invested in the fund if you wanted exposure to dividend-yield strategy. But what if other asset management firms also offer the same product? Then, you should choose the NFO only if its management expense ratio (MER) is lower than its peers. Think of the MER as the total cost that you incur in a year for investing in the mutual fund.

Now, what if the NFO you want is an active fund? You should invest only if there are no passive funds on the same benchmark. And what if there are no passive funds, but only competing active funds on the same benchmark?

You may consider investing based on two conditions. One, you are comfortable with the asset management firm offering the product. And two, the firm does not have a similar product already. Funds typically beat the benchmark in the initial years when their assets under management are not large. Beating the market consistently over a longer time period is difficult.

You can benefit from investing in NFOs. You have to apply simple rules discussed above to decide whether to invest in one. It would be better if you utilise not more than one per cent of your total investment in any single NFO, subject to a minimum of Rs 10,000. You can later set up a systematic investment plan, if you desire a higher exposure to the fund.