A new fund offer is not like an initial public offering in case of stocks. In case of an IPO, the company is going public for the first time before it gets listed on the stock market for everyday trade. In case of an IPO, it’s like you buy a fish when it is very small, wait till it becomes humongous and then sell it to make profits. So here, the entire buying decision is based on the growth prospects of the stock.
In case of an NFO, you initially give money to a mutual fund to create a portfolio. The mutual fund manager, based on the investment objective of the fund, creates an initial portfolio. This portfolio is a collection of stocks and is never constant. It keeps changing based on market conditions and what the manager senses about the market. The performance of the fund is entirely based on the manager’s ability to run the fund, the process that is laid out to execute the entire functioning of the fund, and the investment objective of the fund and not the NAV.
In the case of an NFO, you just feel that you are buying something cheap but the gains you make in case of mutual funds are entirely dependent on the difference between NAV at the time of investment and at the time of redemption. These funds can, however, be rewarding sometimes, but avoiding them is the right thing to do since they do not have any previous track record. This alone is a major red flag when investing in an NFO. Some other reasons for not investing in NFO’s are:
- NO PROVEN TRACK RECORD: NFO’s are basically theme specific and they do not have any previous track record. While on the other hand, if you invest in some open-ended scheme or any current mutual fund, you know their past 3 or 5-year record and hence you get a better idea of its performance. Using qualitative and quantitative techniques, you can ascertain the future performance of the fund whose background is sufficiently known to you. This may not be the case with a new fund since they do not have any past record.
- HIGH PRICE: The NFO’s generally come at a higher price point. The higher price point is due to high marketing expense, promotion expenses, fund manager’s fee, and so on. All these expenses are ultimately charged from the investor. Due to such high prices, new funds are never able to beat their benchmarks. All in all, a large majority of the cost of a new fund comprises of the expenses. In short, the expense ratio of a new fund offer is high and the returns of these funds are not up to the mark.
- LIMITED DIVERSIFICATION: As mentioned earlier, NFO’s are sector specific. This basically means that all your money is invested in different shares of the same sector. For instance, you invest in a new fund and that fund comprises of stocks of only pharmaceutical companies like Cipla, Lupin, Unichem, Pfizer etc. Old mutual funds have shares and debentures of different sectors and hence the chances of loss are very low because all the stocks do not go in the same direction at any point in time. The same might not be the case with the new fund because all your money is allocated in a single sector and your return may turn negative if the sector doesn’t perform well. Also, your portfolio should be diverse, which it won’t be if you invest in a new fund offer.
Some people buy a new fund looking at the low NAV. But in reality, NAV doesn’t affect the returns you get from the fund. Rather, it is a measure of how many units of the mutual fund you will get paying a certain price. All in all, you should refrain from investing in new funds because of the aforementioned reasons.