As equity markets witness one of the strongest rallies ever, asset management companies (AMCs) have taken this opportunity to launch their mutual fund initial public offerings.
The idea is that retail investors should also be able to participate in this growth. However, any investor with even an elementary knowledge of investing basics will bear out that you must enter a market-linked investment at a low and exit at a high.
Does that mean that investors should ignore mutual fund IPOs? Not really. If there is a fit, investors should consider investing in them. The moot point is -- how do investors determine if there is a fit? We have prepared a small checklist that should serve as a guideline for investors.
1. Risk/Return equation
Every mutual fund scheme has a risk profile. Investors decide to invest in the mutual fund after factoring in the risk with the hope of getting a return that will outweigh the risk.
For instance, diversified equity funds carry high risk and have the potential to deliver high returns over the long-term (3-5 years). Sector funds have a higher risk profile vis-à-vis conventional diversified equity funds as they do not diversify across sectors.
Investors should take to sector funds only if they understand the intricacies of the sector and believe that such a high risk strategy will pay off commensurate returns. At the lower end of the risk-return spectrum are balanced funds, which have a lower risk profile due to the debt component.
Having assessed the risk profile of the mutual fund scheme, you must now see if there is a fit with your own risk profile. If your risk profile matches that of the mutual fund, then you can consider investing in the IPO.
2. Asset Management Company
Mutual fund schemes are managed by the Asset Management Company. Before you to consider investing in an IPO, look at the track record of the AMC. Typically, the AMC must be backed by sponsors who have a fair amount of experience in the financial services segment.
Asset management is serious business, because you are dealing with other people's hard-earned money. It calls for a certain level of integrity and responsibility.
If the AMC has been embroiled in a controversy in the past, then we suggest you keep away from it, even if its schemes have put in a very good show.
Ultimately, track record of the AMC must be given its due and if does not make the mark, then its not good enough to look after your money.
3. Fund manager
If the AMC passes the litmus test in terms of integrity, track record and performance, then you must look at the fund manager of the mutual fund IPO. The fund manager needs to be put under the scanner for the same reason and on the same parameters as the AMC.
So integrity and track record are of paramount importance. Don't choose a fund manager because of an exceptional performance during the last bull run. Almost all fund managers do a great job during a rally. See if the fund manager did an equally competent job during the last market slide.
In other words, look for consistency over market upswings and downturns and not mere flash-in-the-pan performances. Admittedly, details on both -- AMC and fund manager, may not be easily available to an investor at 'grassroot level.'
For that, check up with your mutual fund agent/consultant. And even if he does not know, ask him why he is recommending the mutual fund IPO to you.
4. Expenses and charges
Mutual fund schemes (including IPOs) levy expenses and charges on the investor at two levels. One is at the time of investing (through an entry load), which is earmarked to meet distribution/agency commission of your mutual fund agent.
(Remember your mutual fund agent makes money every time you invest in a mutual fund scheme including IPOs, so he is an 'interested' party).
At the second level, mutual funds levy a string of charges like fund management expenses, stock-trading expenses, administration expenses and marketing expenses.
These expenses are related to the working of the fund and deducted from the net asset value (NAV) of the fund; so the NAV you receive, is arrived at after subtracting these expenses. These expenses are capped at 2.50% of the net assets and the AMC cannot levy a charge higher than that level.
Often funds waive off entry load during the IPO to evoke higher investor interest and response. In our view, that is not a good enough reason to invest in an IPO. It is better to pay the entry load and go with a well-managed fund than to invest in an average IPO minus the entry load.
5. Your existing portfolio
Assuming that the mutual fund IPO passes all the criteria outlined so far, it still has to make it to your existing portfolio. For that, there should be a void in your existing portfolio that the IPO can fill. Many investors take to an IPO only because it has everything going for it, forgetting that the portfolio already has many 'look-alikes.'
There is hardly any point in having a bouquet of mutual fund schemes in your portfolio working towards the same investment objective.
There is an unavoidable overlap in your portfolio, which goes against diversification and the size of your mutual fund portfolio could get unmanageable.
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