Mutual Fund NFO: When to buy and How to buy

A mutual fund NFO or new fund offer is one which is available when a new mutual fund is launched. For about two weeks the new mutual fund is available at a NAV of Rs 10 per unit before its assets become marked to market. “Do not buy NFOs” is a refrain often found in articles and personal finance forums. This is because of the way in which new product launches were marketed – a way to obtain more units at a lower NAV.

It is a terrible idea to buy an NFO only because it is available at an NAV of 10per unit. NAV does not matter. NAV growth or the rate at which the NAV changes with times is what determines returns. As long as an investor is aware of this simple fact, one need not shun away from NFOs.

It is also a terrible idea to buy an NFO because there is a buzz about it and people are talking about it. This is exactly what the AMC wants and you playing right into their hand.

Also, one must avoid closed-ended mutual funds.

That said, I would still recommend that new mutual fund investors stay away from NFOs and stick to funds with a solid track record. At least some basic qualitative understanding of the NFO is necessary and the typical new investor may not be able to handle this.

Usually, established distributors do not suggest NFOs. Banks are the main culprits.

When to buy a mutual fund NFO (or a new fund)

(1) You need to be clear about what your equity* portfolio composition is and what your investment strategy is.

(*) For the purpose of this post we shall only consider equity mutual fund NFOs.

Without a strategy and knowledge of portfolio composition no investor should consider buying more mutual fund units – be it inexsiting funds or in new ones (NFO or not).

(2) The above step will tell you if  you need to buy a new fund or not. That is whether there is a vacancy or not.

Vacancies can arise because

a) you do not have enough exposure to a particular market cap sector or geography

b) one of your existing funds has not performed well when comapared with the net XIRR of your equity portfolio and you would like to replace it. Read more: How to review your mutual fund portfolio

c) you may want to add a fund in the same category because your would like to split your holdings between two AMCs. This is relevant only when your holdings are significant. Some articles suggest starting small ticket SIPs in 2/3 large cap funds which is nonsense.

To put it simply, when you want to shop for mutual funds, there must be a precise need to do so. Else your portfolio could easily become cluttered.

So you need to convince yourself that a new fund is necessary in your portfolio. Assuming that there is such a need, one can consider how to go about buying one.

Again, there is no need for a NFO to fill this vacancy. One can choose for a well-established fund, perhaps using this mutual fund screener

Let us admit it, we come to know about a NFO only because of ads (typically AMC mailers), because other investors are reacting to those ads or because a sales guy accosted us with it.

Regardless of the reason, assuming we can justify the need for analyzing the NFO deeper, we can consider it over an established fund. This is a risk, but it needs to be an informed risk.

How to buy a mutual fund NFO

(1) What is the nature of the mutual fund and what is its mandate? What is the asset allocation strategy and where can it invest?

Only the scheme information document can answer these questions clearly. Do not reply on any other source even if it is from the AMC.

If the answers to the above questions are satisfactory and you are convince that the fund would be a good fit in your portfolio, other checks can be performed.

(2) Are you comfortable with the AMC? How long have they been around? Is their first fund of this type?Why are they launching it? Is this part of a bandwagon – that is  part of a similar NFOs launched because of market conditions?

Is there something unique about the NFO or just run of the mill.

Again convincing answers are necessary before proceeding.

Note:  9 NFOs out of 10 will fail the uniqueness test. PPFAS LTVF was a good fit for my folio and I got it while it was a NFO.

(3)  Who will head the fund management team? What funds have they managed or are managing currently? How long have they managed such funds? Do they have a good track record? How long have they been with the AMC? If the NFO belongs to a different category from earlier managed funds, are you comfortable about the fund managers expertise? (perhaps tough to answer)

If such questions can be answered suitably, the NFO investment can be considered.

Pros and cons of a mutual fund NFO

It is akin to starting on the clean slate. For you, the investor, and the fund managment team.  In a turbulent market condition, the NFO has the advantage of picking and choosing stock at will with minimal number of stocks in the folio. A ‘good’ fund manager will use the freedom the NFO offers effectively and beat the benchmark consistently. ICICI Foucssed Blue Chip launched as a fund which will initially invest in only 20 stocks right in the middle of the 2008 crisis is a fine example of this. Of course, in hindsight.

Ask yourself, if Prashant Jain were to offer a NFO, would you consider it? I certainly would. He could operate free from the shackles of large AUM. Although there is no evidence that higher AUM decreases performance, it affects portfolio churning. Prashant could not buy and sell with as much freedom when his funds swelled in size. Read more: Mutual Fund Size vs. Performance: A Case Study

That said, NFO investing is a bit more of a gamble than regular fund investing.  Sometimes it may pay off and sometime it will not. No one can predict the future.

The general hope for the NFO investor is that the funds AUM grows at a reasonable pace:

not too slow -else the AMC would merge it with another scheme or change the funds nature altogether.

not too fast – else the fund manager would struggle with inflows. Tread with caution when it comes to small-cap and micro cap funds. I will not invest in such NFOs during a bull market.

Also the expenses would be high initially  a new mutual fund. If the funds startegy is unique, then I will not mind paying a higher expense ratio.

Conclusion

The statement “do not buy a mutual fund NFO” is not incorrect. It has too many ifs and buts associated with it as stated above.

Buy an NFO only if you need it.

Do not buy for 10 NAV.

Do not buy because people are talking about it or you were ‘suggested’ this fund.

Recognise the pros and cons of a mutual fund NFO.

Poor performance of a NFO is not a big deal as long as you are not emotionally attached to it. Any fund in your folio (new or old) which has failed to perform depsite being given a generous amount of slack should be chucked. The future is unknown for any fund.

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