A new fund unit has a low price (or NAV) because it has lower proportion of underlying assets than an existing fund which has invested in the same set of assets in the past.
Most investors would have heard about IPOs – Initial Public Offerings, and the attendant marketing and media blitz around them, aimed at attracting investors. NFOs, or New Fund Offers, on the other hand do not create such hype.
IPOs pertain to companies new to the market and hence are exciting because they hold the promise of supernormal returns for investors. It is equally likely that investors may lose money on their IPO investment, but they are still drawn by the lure of a quick buck.
An NFO, on the other hand, invests in existing companies. A mutual fund by nature invests in a set of assets such as equities of companies, bonds launched by corporates and government, and even in bank deposits. Hence, any new fund launched will invest in those asset classes. Sometimes funds invest in other mutual funds. These are known as fund of funds. There are times when new funds are launched for different sectors or on a different theme which generate immense interest in investors.
Let us look at some of the criteria pertaining to NFOs that an investor must assess before investing in NFOs.
Active versus Passive Fund
An active fund, as the name implies, is managed actively. The fund manager analyzes various companies and bonds available in the market and invests in them. If there is any change in the prospects of the company or the assets invested in, the portfolio is restructured by dropping the company or bond and including new ones.
Passive funds, on the other hand, track an index. The most common ones are index funds that track the Nifty or the Sensex. These funds are called passive because they invest in the companies forming the index in the same proportion. Naturally, an active fund has higher management expenses or expense ratio than a passive fund.
Investment style and strategy
Investors should also look at the investment style of the fund. A new fund can be focused on blue-chip companies that are stable and financially strong. These companies are a safer bet but the returns are also moderate. Other funds can choose small cap companies and invest in them. These funds have the potential to deliver high returns but the associated risk is also high. Some funds may focus on providing dividends and may invest in a mix of fixed income securities and dividend-paying companies while yet others may focus on specific sectors. Investors should look at the underlying assets and also the risk factor associated with new funds before investing in it.
Sometimes, asset management companies come up with new types of fund that can be considered by investors. For example, a company may launch a global alternative energy fund that invests in companies across the globe which are into alternative energy such as wind, solar etc.
Expense ratio as compared to “similar” existing fund
Often, there are existing funds that have the same asset mix and composition as a new fund offer. In such a case, it doesn’t make sense to invest in a new fund unless there an added advantage. In such cases, it is better to look at the expense ratio of the new fund offer. If it is lower than the existing fund, you can think of investing in it.
Finally, a common myth that prevails in stock markets is that low-priced funds or stocks are cheaper. Nothing can be farther from truth. A new fund unit has a low price (or NAV) because it has lower proportion of underlying assets than an existing fund which has invested in the same set of assets in the past.
For example, a unit of existing fund which comprises X units of underlying equities A and B will cost more than a new fund which comprises of X/2 units of the same securities. However, the returns will be proportional, i.e. the existing fund will appreciate twice as much. Hence the returns (profit percentage) will be the same in both the cases if other expenses are same.
The author is CEO, BankBazaar.com