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Buying a new fund? Read this

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May 24, 2006 08:48 IST

In 2005, there were about 40 launches of New Fund Offers, garnering over Rs 25,000 crore (Rs 250 billion).

The attraction of a NFO to the investors is indisputable. Asset Management Companies are shoring up their Assets Under Management like there is a no tomorrow.

Reliance Equity Fund garnered over a whopping Rs 5,700 crore (Rs 57 billion) in one NFO; this is equivalent in size of a small AMC.

What is it that drives investors to these new issues proverbially like a moth to a flame?

Aggressive marketing by asset management companies, superb advertising campaigns, media fanfare and pushy distributors tempt investors.

They find the lure of a new fund offer irresistible.

I guess, it is the psychological factor which makes them feel that they are getting allotment at Rs 10, which is 'cheap'. They fail to distinguish between a primary NFO and an equity Initial Public Offering.

The primary difference between an equity IPO and a mutual fund NFO is that equity IPO can be perceived to be undervalued and there is a possibility of potential gains on listing.

But in the case of a mutual fund NFO, the money mobilised is deployed in purchasing stocks from the stock market at then current market price. The Net Asset Value on listing shall reflect the prevailing market price of the scrips in the portfolio constructed.

So there is no earthly reason to be excited about listing gains.

But the investors of new mutual fund schemes do not seem to see the difference in this fine line.

Existing schemes come with track records have been in the business a while. Their portfolios are constructed and are available for your inspection. You can judge their performance against the backdrop of various market cycles. The performance can be benchmarked and the fund manager's ability gauged.

Against this, in a new fund offer, you start from scratch with a clean slate.

But, to be fair, the AMCs have been quite creative and have structured lots of new schemes with innovative themes. So, when is it that you can consider investing in a new fund offer?

Keep these points in mind:

1. If the NFO is from a fund house you do not have exposure to, you can consider investing. Take a look at all your current mutual funds. Do you have any from this fund house? If not, consider it. But don't do it blindly. The track record of the fund house, its investment style, the fund manager's track record are all crucial inputs.

2. If the concept of the scheme fits into your portfolio, invest. Say if you do not have any exposure to a midcap scheme, then you could consider investing in a Kotak Midcap or an SBI Midcap. Or you could consider putting your money on a theme that is novel in nature and where you are optimistic of its future prospects, say like a Birla Gen-Next or a Kotak Lifestyle.

3. If the concept of the NFO is venturing into virgin areas whose prospect seem to be bright. For instance, Templeton Equity Income fund which plans to invest in global equities; this was allowed earlier as well, but with a lot of restrictions.

4. If the NFO fits into your overall asset allocation, then opt for it. Let's say you need to increase the number of debt funds in your portfolio, but you also need monthly income that is tax efficient. If a NFO hits the market that is debt-oriented under the Monthly income plan category -– by all means subscribe.

Here are some examples of innovative ideas fund houses have come up with to capture current trends:

  • Sundaram SMILE: Investing in small and midcap stocks.
  • Franklin MultiCap: Bottom-up approach to investing in stocks across the market capitalisation
  • Tata Services Industries: Investing in companies which comprise of the services sector.
  • PruICICI Infrastructure: Invests in scrips of companies from the infrastructure industries.
  • Optimix Income Multi Manager: Invests in income schemes of other mutual funds.
  • Standard Chartered Liquidity fund: Liquid scheme investing majorly in MIBOR linked instruments.

Mutual fund regulator Securities and Exchange Board of India has plugged the practice of charging 6% to open-ended new fund offers (*see below for explanation). Now, SEBI has scrapped this provision and the funds will have to meet the expenses from the entry load itself.

As a result, we have seen more close-ended funds being launched.

As long as this was prevalent, distributors (the mutual fund agents) were offered extremely high upfront commissions.

The party for distributors is now over. No new investors can enter a close-ended fund and the ones who have invested will be charged a heavy fee if they exit (sell units) soon. So distributors who encouraged their clients to sell their funds when they made a profit and buy into new schemes will no longer be able to rake in money from the churning of clients' portfolios.

Hopefully, now, NFOs will only be launched when there is a gap to be filled in the AMC's portfolio or when it wants to tap into a genuinely good new idea.

Investors should keep in mind the above mentioned points before blindly rushing to subscribe for an NFO's.

Amita Shah