Should you invest in NFOs or existing MF schemes?

Investors are usually attracted to new fund offers (NFOs) as units of these new schemes are issued at the face value of Rs 10 per unit. Investors erroneously think that the price of the units would go below the issue price and would only go up and so there is no risk involved in subscribing to the NFOs. In contrast, investors think twice about investing in existing mutual fund schemes as these are usually available at a premium and so they are wary that their returns (in the form of dividend and capital appreciation) would be lower or even negative.

All the above assumptions about NFOs and existing mutual fund schemes are based on misconceptions and faulty understanding about mutual fund schemes. The fact is that investing in existing MF schemes with good track record of past performance makes eminent sense as one can reasonably expect the fund manager to keep up the good work, while investing in an NFO is a risky affair as the fund manager does not have anything to show for his performance.

No doubt, since mutual funds are subject to market risks, the net asset value (NAV) of the existing mutual fund scheme can go up or down, depending on market conditions. Hence, subscribers to an existing mutual fund scheme can also find the NAV of the scheme going below their purchase price due to adverse market conditions. However, an experienced and qualified fund manager can pre-empt and even beat such a situation by being pro-active in his management of the fund’s assets.

In the case of NFOs, the timing of the launch of the scheme is crucial to the success or the failure of the scheme. It has been observed that asset management companies (AMCs) usually launch NFOs during a bull phase when the market is at its peak. This makes the task of the fund manager difficult as he has to invest the fund corpus, notwithstanding the expensive valuations. If the fund manager of the NFO miscalculates or slips-up in his judgement and makes wrong choices in the investments, the NAV of the fund can go below the issue price, causing loss to the NFO subscribers. As for returns on NFOs as compared to returns on existing schemes, a well-managed MF scheme with good track record of performance can provide excellent dividend yield as against a new fund which is yet to prove its worth in terms of performance.

To draw an analogy, investing in NFO is like investing in the equity capital of a new venture, while investing in existing mutual fund scheme is like investing in the stock of an existing company with track record of financial performance.
Of course, this does not mean that NFOs should be avoided at all costs. After all, the existing MF schemes were NFOs too when these were launched, so one can look at the credentials of the fund house and the professional qualifications and past track record of the fund manager before investing in an NFO.