Should I buy the new fund offer? This is the question we frequently come across and there are many investors including you must be thinking about the same. The popularity of the new fund offer (NFO) is not a recent phenomenon. But it is more of a case of ignorance of some of the ground realities than anything else.
First let us understand the reasons why we come across so many new fund offers. All fund houses are compensated in terms of fees. The fee is a function of assets under management. More the assets under management more the fees and vice versa.
Simply put, if a fund house is successful in pooling in more money under its management, then it will also succeed in garnering more fees. And for this simple reason the fund houses come out with new fund offers. It is more to do with the augmentation of more assets under management than the true investor interest enhancement.
Now let us understand how NFOs are sold and how the expenses are managed. For the open ended equity NFO as per SEBI norms the AMC can't pay more than 2.25% commission to distributors. However the maximum commission payable to the distributor is 6%. I think all our smart readers understand that why nowadays there is a glut of closed ended equity schemes.
The commission offered on the NFO are the highest possible and certainly higher than the commissions offered for selling of the on going schemes by mutual funds. Naturally the distributors are keener to sale the NFO than the existing schemes. At times some selfish distributors make the investors sell their existing holding and invest the proceeds into NFO.
Before we discuss whether one should invest in NFO, one must also note one more factor that eats into her return on investment. As per SEBI norms, the initial expenses (read advertising expenses and commissions paid, etc) will be amortized over the first five years of the schemes.
Consider a case. A leading mutual fund came out with an NFO in 2005. It could garner Rs 1200 crore in NFO. However in 2006 the fund left with just Rs 68 crore. Simply put if the expenses incurred to augment Rs 1200 crore were charged over a period of five years, in the first year the expenses were charged on Rs 1200 crore and in the second year the same expenses were charged on Rs 68 crore only. Here if the AMC has incurred let us say 5% of Rs 1200 crore (Rs 60 crore) as the initial expenses, it would amortize Rs 12 crore each year. In the first year Rs 1200 crore bared Rs 12 crore expenses which amounts to just 1%. However in the second year only Rs 68 crore bared the burden of Rs 12 crore initial expenses which amounted to almost 5%. The 5% charge exclusive of the recurring expenses for that year.
Though this is an extreme case, one must note that the NFO investors must fork out the costs. Also understand that the big fish that bring in money in excess of Rs 5 core need not pay any entry load and exit load. In essence, the small investor pays for the big fish. Hence, we typically don't advise our clients to buy into NFO as such.
Still NFO is not all together a bad proposition. One must understand why NFO is being floated. If you as an investor come across an NFO that has something unique on offer and it is in line with your investment needs then you may consider such an offer.
Consider this example. We have many NFOs offering international equity exposure hit the capital market few months back. Couple of years ago, Templeton MF came out with such a scheme where 65% of the moneys will be invested in Indian equity and rest in global equity. 65% investment in Indian equity brought it tax exemption on long term capital gains tax. There are many NFO that hit the market in this segment and lapped up by many investors. However those schemes were not the true investment in international equity. Instead an offer from Birla Sun Life MF the international equity scheme which invests in global equity without any restriction of investing in Indian equities, was the only true international investing option available till date. We liked that and suggested our clients in addition to the Principal PNB AMC offering on similar lines.
Here one must know what is so unique about the offering. The offering must offer you something which is not available in the market as on date and if you don't subscribe to it you will stand to lose something. The schemes that are in existence for at least five years are done with their initial expenses and the new entrants after that need not bare the burden. This enhances the returns.
One more excuse that we get from investors when they prefer to buy an NFO over an existing 10 year old scheme is the NAV. A scheme that comes out with an NAV at Rs 10 is treated to be cheaper than the one with NAV of Rs 500. However the absolute NAV should not be the worrisome factor.
Consider two schemes. Scheme A – an NFO and NAV at Rs 10. On the other hand scheme B- a scheme with 12 year history and NAV at Rs 250. Here the high NAV connotes the performance of the fund manager over the long run. The low NAV is like an experienced worker you are hiring who may not perform.
Now assume that you invest Rs 10000 in each scheme. Scheme A offers you 1000 units and scheme B issues you only 40 units. Assume both the fund manager invest in same basket of stock. And the basket returns 20% in one year. The NAV of both the schemes will go up by 20%. Scheme A NAV will quote at Rs 12 and scheme B will quote at Rs 300. In other words, if you chose to redeem your holdings you will get Rs 12000 each. Simply put, NAV has no bearing on the performance of the investment or nothing like cheap or dear mutual fund because of low or high NAV of the mutual fund.
After going through the above discussion you must have realized that NFO is not something you should blindly go after. Do your due diligence and then decide if you really need to get into one.
Article courtesy: umcapitalindia |
