New Fund Offers Vs. Existing Funds – Choosing Mutual Funds
Some of us believe in having the latest gadgets or trying out new things. For example, latest smart phone, recent version of a net book, shoes, etc. In some cases buying new clothes, new car, a new refrigerator may have something to do with either necessity or a matter of lifestyle. Whether it is a basic need or a secondary need or a luxury, would depend on the lifestyle of the person in the situation.
When you choose any mutual fund you need to know the investment objective, how it fits in your portfolio, fund manager’s track record, past performance of the fund and various other factors. This is true for both new fund offers as well as existing funds with a long history.
Generally speaking Mutual funds with a reasonable track record and good management is always better and safer than new fund offers (NFOs).
There are many factors which tilts the balance in favor of existing funds as against new fund offers. Let us look at the salient factors:-
Parameters to be Considered
1. Track Record
When deciding to opt for new fund offers, one has to look at the track record of the fund in terms of returns and performance in various market conditions. A consistent track record is more important than a few record breaking instances. For instance if lets look at a small illustration below:
Comparative Returns Table
|Fund||1 year||3 years||5 years|
Generally when we analyze equity mutual funds its important to look at a performance over a period of atleast 3 years since equities are meant for long term investment. Here Maaza Fund is preferred looking at 3-year returns. Secondly, the returns have to be consistent or good over the years.
In case of Maaza Fund the returns have been consistent and higher for longer period, but Taaza fund seems to provide kicker returns in the short run, but shows poor performance over the long run. This is just one example there are various factors that can be evaluated from past historical records.
2. Mutual Fund Charges
New mutual funds generally have high entry loads because the fund intends to cover its initial costs involved in marketing, publicity, commissions given to distributors, etc. According to SEBI rules Asset Management Companies are permitted to collect up to 6% from the collections of an NFO issue. These costs are recovered during the initial few years of the scheme. A high upfront charge also impacts the effective returns for the investors.
But in case of existing mutual funds the charges are minimal. The entry loads for an existing fund could go up to 2.5% (max) generally, which is relatively lesser than that of new fund offers.
3. Fund’s Expense Ratio
Expense ratio indicates the ratio of the funds operating expenses in relation to the total assets under management. Generally this is indicated in % terms. The expense ratio for index funds such as HDFC Nifty Fund is around 1%, and this is generally in the range of 1-2% for most index funds barring few exceptions.
Diversified Equity Funds such as BNP Paribas Equity have an expense ratio of 2.5%. (Data Source: Value Research). So the expense ratio varies depending on the type of fund.
In case of most NFOs the expense ratios will be high in the initial year or a couple of years because the company may have to do a lot of research, stock selection and hire a team, etc. These initial costs can impact returns.
4. Fund Manager’s Experience
In case of an existing fund the Fund Manager’s or the team itself possess a good amount of experience and track record, which proves their potential. It is also possible to track the funds performance and take corrective action if the investment style or the processes followed are not in line with your financial goals and risk appetite.
But in case of NFOs investors have no clue of whether the fund is performing in line with a benchmark or has met investment objectives until they actually build a portfolio and show performance, which is evident only after a period of 6 months or so. There are cases where new funds hire experienced fund managers but a new fund will have its challenges to face until it reaches economies of scale.
Key Question to Ask
Before you invest in a new fund offer, you have to ask this question “How is it different from existing funds in terms of meeting my investment goals?” If you have sufficient evidence to show that the new fund is providing something different or unique then you can consider it provided it is not available in existing funds.
For instance there were a few gold funds launched which was a novel idea. I’m not sure about their success or response, but a few investors who bought these would have reaped some returns. Although I’m not recommending these funds as such they are still new and offer something different from what other funds do.
If the new fund offers entry in to a new sector or asset class which you are currently not exposed to it might be a good idea to consider or try out the NFO. The key point to note is the most mutual funds that are being launched are just old wine in a new bottle.
Units Available at Par in NFO (which is a misconception)
Many investors believe that a new mutual fund offer is a good entry route to buy a fund at Rs.10 or par value. This does not make sense, because the Net Asset Value (NAV) of a fund is just a measure of one unit of the fund. Whether the NAV is Rs.10, Rs.50 or Rs.100 or higher is not the criteria to decide investment returns. One needs to look at the relative returns compared to the investment made.
For instance if Gopal invests in a fund with Rs.10 NAV and Satish invests in a fund with NAV of Rs.90. Assume that both funds invest in large cap stocks which are positive and appreciate over the next one year. After one year Gopal’s fund has NAV of Rs.11 while Satish’s fund has an NAV of Rs.102. Which fund has performed well. Can you guess? Give it a try before you read further.
- Returns on Gopal’s Fund = Rs. (11-10) / Rs.10 = 1/10 = 0.10 or 10%
- Returns on Satish’s Fund = Rs. (102-90)/ Rs.100 = 12/90 = 0.1333 or 13.33%
Satish’s Fund is better because it delivers more returns. If you think this number is insignificant it can make a huge difference in medium to long term. Satish would be able to double his money in about roughly 5.5 years while Gopal will take roughly close to 7.3 years to double his investments.
New mutual fund offers are good source of revenue for distributors and agents, because the fund pays them to enhance its initial marketing and make the product launch successful. Moreover, many funds try to pay higher commissions to boost their Assets Under Management (AUM), which is a cause of worry.
The market regulator SEBI is taking note of these industry practices and putting adequate safe guards in place, but still a few unhealthy practices continue to happen. There are still dozens of NFOs coming out from funds with hardly any new product, innovation or theme.
Either funds have to admit that the good old investing ideas and philosophies are good, or admit that they have run out of new ideas and themes. Mutual funds is another business, so its in your own interest to make sure that you invest in a fund that has a solid track record and testimonials to prove its performance over the years. This means you don’t have to chase the new funds.
New fund offers are a definite “No-No”, so one should not even think about investing in them. Investing in them to explore a new theme could be a reason to consider NFO, but that is again risky because there is no track record to make a proper evaluation. Would you be willing to invest in a penny stock just because it is trading in single digits ? If you do decide to invest you also have to face brickbats when the price plummets by 50% or more within a few weeks or months.
Beware of Marketing Gimmicks
There is no harm trying out a new outfit, buying the latest high definition television, etc. I’ve seen people investing in LCD TVs but having a shabby cable provider (non-DTH). Had they switched over to DTH which costs the same or marginally higher, they would get digital quality and crystal clear screen even on a normal flat TV screen.
NFOs are not very different from the electronic major who come up with newer technologies with new USPs (unique selling propositions) such as high definition, LCD, LED, etc.
There is nothing wrong in switching to a better technology, but shelling out tens and thousands for a gadget which will become scrap in a few years is a criminal waste. There are cases where advisors and agents encourage clients to sell their existing stocks to buy new fund offers, and justifying how the switch will provide them with better returns or improve their portfolio.
This is one bad practice that has come under regulator’s scanner and steps are being taken to minimize this.
The key message is to stay away from New Fund Offers when you have hundreds of funds to choose from. One must do some basic research and choose mutual funds which have a decent track record. To make this process simpler you can visit mutual funds research portals such as Value Research (Value Research) or other portals.
On Value Research site you can shortlist a few 4 star or 5 star rated funds which are considered to be the best performers. Out of the shortlist you can make your favorite picks.
A couple of points for mutual funds investors – one is to invest through a Systematic Investment Plan (SIP). The other tip is to explore asset classes such as gold (i.e. Gold ETFs) to provide some protection and safety to your portfolio. Investing in equity is risky and can deliver decent returns in the long run, which is true for stocks, mutual funds as well as ETFs.
So try to invest systematically and hold for the longer time frame to earn better returns across different market cycles. Follow the systematic route to success.