Tuesday, June 23, 2009

NFO - No Fun Offer

New Fund offers or NFOs, as they are popularly know, are quite popular among lot of people for various reasons but the most important factor which is responsible for the popularity of NFOs is the notion among investors that NFOs offers units at a discount or at a cheap rate. They feel since NFOs offer units at NAV of 10 , they are better off investing in an NFO as against investing in other schemes where the NAV is higher than 10.The feel by investing an X amount in an NFO they will get more units and hence would be better off. This is completely wrong theory about NFOS and NFOs are in no way cheaper or better than other funds available in the market.
Let us examine this in detail . Now, the question that we need to answer is this : Do we invest in a fund to make more money /return or to buy a unit at lower NAV? the answer is obvious. There are various drawbacks of a NFO , some of which are mentioned as under:-
1. NAV of 10 does not mean you are better off - Return on any investment is determined by the following formula
Return = (NAV at the end of the review period-NAV at the start of the review period)/NAV at the start of the review period X 100
Now, let us take an example of Rs 1000 being invested in 2 funds . One is an NFO offering units at NAV of Rs 10 while the other one is an existing fund with NAV of 12. So the units that one gets in both the fund will be
NFO - 1000/10 = 100Existing fund - 1000/12 =83.33
Now , assuming at the end of 1 year the NAV of these funds are as under
NFO - 12Existing fund- 15
The returns in both these funds at the end of 12 months
NFO = (2/10)X100=20%Existing fund = (3/12)X100=25%
Total fund value at the end of 12 months
NFO = 100X12=1200Existing fund = 83.33X15 = 1249.50
So , you can see that in the existing fund, the returns are more than the one in NFO even though the NAV of NFO at the time of entry in the fund was lower than the NAV of the other fund.This establishes the fact that the return on your investment does not depend on the NAV of the fund when you enter into it. It depends on the growth in NAV during the time you enter and the time you exit. Hence, the notion of NFO being a better option simply because they offer NAV of 10 is completely false one.

2. NFOs have higher charges - NFOs have higher charges than an existing fund since they have to spend on marketing and sales promotion of the fund. A new fund is launched amidst much fanfare and all this cost money. Even the sales commission for an NFO is significantly higher than the existing fund and all this add up to increase the charges. NFOs have first year charge of 3-4% as against a charge of 2.25% for an existing fund. So, you end up loosing money in an NFO because of these unnecessary charges.
3. NFOs do not have any track record - The most important principle in mutual fund investing is that one must invest in a fund having proven track record of at least 3-5 years , if not more. This ensures that you are putting money in a good fund which has delivered goods consistently over a period of time. This reduces the risk for an investor to some extent. But,NFOs do not have any track record and as an investor you are pretty much taking a big chance with the fund. The fund may or may not do well. All NFOs do not tend to become great funds .

Since NFOs are in no way better than an existing fund , then the question is why are they so popular? They are popular because of NFOs offer companies to package their fund in a unique way and they also play on the mindset of investors that low NAV is better for them. An informed investor will stay away from NFOs and would invest in funds which have performed exceedingly well over 5-10 years. Why would you like to take a chance with a newcomer when you have a veteran ready to take care of your money.

3 comments:

  1. Rajeev,
    I would like to ask some questions on some of your points.
    1. NAV of 10 does not mean you are better off -
    In your example, after one year NAV is increased by 20% of new MF and existing MF has been increased by 25%. Then obviously return would vary in same proportion. I can not understand why have you increased two MFs by different percentage while comparing.
    2. NFOs have higher charges -
    How can fund manager charge me more than entry load? Can they?
    It may possible that they have more expenses in first year and can not put all money in market which could result us some loss.
    Do u mean expense instead of charge?
    3. NFOs do not have any track record -
    Completely Agree.
    Please feel free to point out if I am wrong. I hope you don't mind on my commnent.
    Thanks,
    Sandip Sabnis.

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  2. Dear Sandeep

    I agree with your point that a variable increase in NAVs will obviously mean a variable return, but , the difference is taken to drive home the following points
    1. Increase in NAV depends on the fund management and expertise of the fund manager and not on the NAV value.
    2. Even funds with higher NAV are capable of delivering higher returns, since, the performance depends on its management and sound investments.

    And NFOs do have higher charges , even if they charge only 2.5% as entry load, there are other charges like fund management charges,admin charges etc. AMCs do apportion the sales and marketing charges to the fund which is separate than the entry laod that the investor pays. This reduces the actual money invested in the fund and hence the likelihood of the better returns are that much lesser. Explains the first point as well.

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