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NAVia Mania! Since time immemorial, man’s insatiable appetite for something new is well known. Mutual Fund NFOs are no exception. What makes the idea of investing in a new fund tick? Does it make sense to invest in NFOs? The answers unfold… NFO NAV at Rs. 10 is cheap - this myth surrounding the NAV (Net Asset Value) is the underlying reason as to why mutual fund NFOs (New Fund Offers) have been selling like hot cakes. Mutual Fund NAV merely represents the market value or the book value of the portfolio minus its liabilities backed by each unit. In a stock, the book value (its intrinsic worth) and market value (determined by market factors) are divorced from one another. The earlier appreciation of the old fund due to appreciation in its portfolio does not make it expensive vis-à-vis an NFO since the returns over a given period of time will be the same from an existing portfolio (with a higher NAV) and an identical new portfolio (with Rs.10 NAV). Now let me make this point clear by using an analogy. If you are investing Rs 100,000 in Fixed Deposit (FD), there would be 4 Fixed Deposit Receipts (FDRs) if the denomination is Rs 25,000 and 2 FDRs, if the denomination is Rs 50,000. If you choose to invest in 4 FDs of denomination 25,000, it does not mean you have got those cheaper and therefore you will earn more interest. Please appreciate that the level of NAV is as irrelevant in Mutual Fund investment decision as the number of the FDRs while investing in FD. It is just an equation; as long as the numerator (investment amount) does not change, the denominator (NAV / number of FDRs) does not have ANY material impact on the return potential of your investment. A few valuable lessons need to be learnt – NFO NAV at par has absolutely no role to play in your future returns. Quality of the portfolio, rapid deployment of resources and in-built flexibility are the key to fund performance. Uniqueness of NFO makes eminent sense. Ideally a new fund should have something unique to offer. Derivative Funds, Fund of Funds, Gold Funds etc. are some of the examples of new concepts. But no sooner one theme hits the market than scores of similar funds follow. HDFC Core and Satellite, Magnum Comma and Benchmark Split Capital Fund are among the more unique funds that have not been replicated so far. Business (non)sense! Fund management is a business. Fund companies make money on the money they are able to collect from the public through Funds. AMCs prefer to launch new funds in different flavours whether you need them or not. But AMCs are better off focusing on their existing offerings rather than adding NFOs that have little value-added and make a guinea pig of you. Distributors on the prowl….. Most distributors sell only NFOs, but then AMCs should hardly be launching NFOs at the behest of distributors. AMCs offer distributors upto 6% commissions for selling NFOs. If you buy a fund anytime after the NFO, the distributor gets only upto 2.5%. No wonder distributors want to sell the NFOs. So who pays for this commission? If you buy a fund after the NFO, this is usually an "entry load", meaning you get charged upto 2.5% of your money upfront to pay the distributor. In an NFO, it is a "hidden" cost. Though many NFOs come with zero entry load, SEBI allows fund houses to charge upto 6% of the money collected as "NFO marketing fees”, part of which goes to the distributor and a part to the advertisements. Since this is usually taken out from the net assets of the fund, the NAV goes down, sometimes below the issue price. …..Closing in on close-ended Funds Under SEBI rules, mutual funds can write off these marketing expenses from the NAV over a period of 5 years. In an existing scheme, especially those more than 5 years old, these expenses would have been written off. Therefore, all things remaining the same, the net returns from an NFO would be lower to the extent it has to write-off the issue expenses, vis-à-vis an existing scheme. With the SEBI guidelines in July 2006, all the expenses have to be either met out of the entry-loads or netted off from the open-ended NFO on day one. As a result, an open-ended NFO will always open at NAV below Rs 10. Hence the deluge of close-ended funds (standalone and serial) in recent times. From Guinea Pig to King There is a case for evaluating an NFO as a probable investment if the NFO is from a well-managed, process-driven fund house, has a unique theme to offer, matches your investment objectives, adds diversity and is open for a limited time period and you are comfortable with its risk profile. Otherwise, avoid using the NFO route (including serial NFOs on the equity side) to increase your exposure to mutual funds. Investing in a series of NFOs could saddle you with an unwieldy portfolio. If you have invested in an NFO, give the fund a chance to perform. A good fund or theme may underperform for a brief period due to difficult market conditions. Evaluate its performance a year on and hold on if the performance has been impressive or switch to a well-established fund if it dramatically trails the benchmark index for several months. An NFO must establish a track record over the long-term (at least 3 years for an equity-oriented fund) before meriting inclusion in your portfolio. Established Funds with inherent strength and consistent performance should rightly enjoy a royal treatment in your portfolio as opposed to run-on-the-mill funds or NFOs which in reality is a gigantic gamble. This will go a long way in establishing a regime where you the investor are the king! .
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n Mrs. Lalitha Muthu e-mail : lalitha_ppm@yahoo.com |
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Articles by Lalitha Muthu |
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Investing in NFO |