Ask in any personal finance forum, “Can I invest in XYZ NFO?” there would be an immediate refrain, “Never buy NFOs!”. Context is often the first casualty in such a forum, and this response is no different.
All mutual funds carry a past performance disclaimer – past returns do not indicate future returns. Then why can’t I invest in a mutual fund NFO?
Everything we know about a mutual fund is based on past performance. From a simple NAV to returns, to one of these Greek risk-adjusted measures, alpha, beta, etc., to the style of a fund manager, the nature of the portfolio, PE, PB, everything is a data point in the past.
No matter how great the track record of a fund, no matter how consistent, mutual fund investing (like other personal finance purchases) is a leap of faith. So why can’t one take that leap with an NFO?
We are always learning new things about the market and market risk.
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- Active funds find it tough to beat the index. Myth Busted: Active mid cap mutual fund managers can easily beat the index
- The Nifty Mid cap 150, which had always matched the performance of the Nifty Next 50, has pulled ahead for the first time in the last couple of years. Nifty Next 50 has been underwater compared to Nifty 50 for the longest time recently. See Nifty vs Nifty Next 50 vs Nifty Midcap 150 vs Nifty Smallcap 250.
- Nifty Midcap 150 Quality 50, which had such a stellar backtested record, has struggled recently. See NSE Index Watch: Biggest winners and losers of 2022
- A few years ago, no one could have imagined an equal-weight index (Nifty 100 EW or Nifty 50 EW) to deviate so much from their parents, Nifty/Nifty 100, because just a few stocks were responsible for the movement of the Sensex/Nifty. See Return difference of the Nifty 50 vs Nifty 50 Equal-weight index at an all-time high!
- We constantly see examples of past performance not meaning anything: Ten-year Nifty SIP returns have reduced by almost 50%, and Franklin India Bluechip Fund has not beaten the Nifty for the last 11 years! And Misconceptions about the Nifty PE
- The definition of a “high PE” has constantly changed, and the Sensex was not overvalued when it crashed in 2008 (by its own PE track record). Even the technical definition of a PE has changed, rendering all past history questionable, if not meaningless.
- We have seen past star performers in the MF spaces relegated to average or below-average slots (e.g. DSP 100, HDFC 100, HDFC Equity, HDFC Taxsaver, etc).
- A look at the rolling returns graph of any index or mutual fund would tell you expecting returns from mutual funds is a mistake.
Since past performance is of little relevance to the future, since buying mutual funds boils down to potluck, there is no harm in buying mutual fund NFOs.
However (there is always a however!), an NFO purchase makes sense only if it holds a unique place in your portfolio, only if you can measure the impact of that fund on your portfolio, and only if you can clinically evaluate if there is something unique/good about the fund.
If you already hold ten funds, then just about any NFO would buy more of the same stocks you hold. In this case, an NFO purchase does not make sense.
It is a mistake if you get enticed by a bank RM’s exaggerated statements about an NFO. It is a mistake if you think purchasing NFOs will get cheaper units (at Rs. 10) and, therefore, more returns.
NFOs should be avoided because most people do not need them. Most of these have nothing better/unique/different from what is already available (often at lower expenses), and investors would already have them.
However, there is no logic to the advice, “avoid NFOs because they have no track record; prefer a fund with a good track record”. No logic because it would mean we are ignoring the past performance disclaimer!
Few investors would have the logical space in their portfolios to accommodate an NFO. But would they have the necessary guts? Experienced investors must summon enough courage to discard past performance and expect market movements with an open but prepared mind. We can sleep better when we remove expectations from factors we cannot control.
Note: Readers may be aware that I purchased two NFOs – Parag Parikh Flexicap (because I had the space in the portfolio), UTI Low Volatility Index Fund (as a replacement for Quantum Long Term Equity and, well, I like low volatility!) and a new fund – Parag Parikh Conservative Hybrid Fund (because I needed a debt fund in the portfolio). So far, so good – just luck. That’s it.