Investing: New-found love for NFOs

AMCs may launch more NFOs as markets rise, but new investors could avoid closed-ended equity schemes

With the markets on a roll, mutual fund houses are launching a series of closed-ended equity new fund offers (NFOs) to attract retail investors. Till September this year, asset management companies have mobilised nearly Rs 5,000 crore from these closed-ended equity NFOs. These equity NFOs have a lock-in period of three to five years to ensure there is no flight of capital from the schemes over the investing period.

The asset management companies (AMCs) launch NFOs before opening up for daily transactions. It is similar to initial public offerings (IPOs) of the stocks where one buys the equity before it lists on the exchanges. There are two types of fund — actively and passively managed funds. In actively managed funds, the fund managers outperform the market using a pre-defined strategy. On other hand, passively managed funds are those that track an index or a commodity. Gold ETFs, gold fund-of-funds and Nifty-based mutual funds are some of the passively managed funds.

Brijesh Damodaran, the managing partner of BellWether Advisors LLP, says between September and December last year, while stocks were trading at attractive levels, there were very few takers for them. “This is where mutual fund houses started offering equity schemes for over three years. The holding period is important because based on the past performance, returns generated are seen to be higher. This is where the concept of closed-ended funds gained traction,” he says.

Experts say it is always better to analyse the performance of previous NFOs to make an investment decision. They say it makes sense to buy a fund that is already available for some time and has a track record of performance. In closed-ended equity NFOs, investors do not get the option of systematic investment plan (SIP) and one has to invest in lump sum. In fact, SIP route gives an investor the benefit from rupee-cost averaging and one can gradually step up the amount as one’s investible surplus increases. However, for the first-time investors, analysts say one should avoid closed-ended equity NFOs because if markets tank before maturity of the scheme, the investment can sink.

Closed-ended funds are not new as equity-linked savings schemes (ELSS) also have a three-year lock-in period. An investor gets tax benefit under Section 80C of the Income Tax Act by investing in ELSS. The annualised returns generated by the top quartile of the ELSS funds for three to five years are over 18%. Some of the reasons for fund houses to launch closed-ended NFOs are cheap valuation, lower price-to-earnings, and improved earnings per share.

Fund houses are expected to launch more NFOs as the rising markets are expected to provide steady returns and investors’ risk appetite also goes up gradually. Last time, the NFOs saw a boom in 2008 when the fund houses had launched 40 equity schemes and mobilised over Rs 20,000 crore in both open and closed-ended schemes.

In closed-ended equity NFOs, investors have to stay invested for three to five years depending on the scheme. While these units get listed, it is difficult to sell them in the secondary market. Experts say closed-ended debt funds work well unlike closed-ended equity funds as the stocks markets can remain volatile for a longer period. In fixed-maturity plans of debt funds, a fund manager buys paper matching the scheme’s tenure and one can redeem the units only after the maturity of the scheme.

A mutual fund investor must assess his risk ahead of investing as every mutual fund scheme carries some risks. While equity funds have the highest risk, liquid funds carry the least risk and one must choose the scheme based on his risk appetite. An investor must have clear goals and invest in a scheme that is likely to offer the best return, in the chosen time. Equity-based mutual funds are preferred for goals that are at least five years away. Moreover, one must make a financial plan and invest accordingly. In the long-term, investments through SIP have usually offered better returns.

Retail investors must stay invested and never time the market. It is better to invest early and stay invested so that one’s money has enough time to grow through compounding and one must avoid churning the portfolio unless it is absolutely necessary. Mutual fund investors must not always look at at the net asset values (NAV) as, unlike stock prices, the absolute value of an NAV does not indicate anything about the quality or performance of the scheme. An NAV is simply the function of the total asset under management and the number of outstanding units. One must monitor his investments regularly and take corrective steps to make the corpus grow.

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