NFO’s Making A Comeback: Should You Go For Them?

Rising equity markets are synonymous with IPO’s (Initial Public Offerings) from companies, and NFO’s (New Fund Offers) from Mutual Funds. Although both are structurally different from each other, the underlying motivation behind launching them are usually the same – that is, cash in on the euphoria and fill your coffers!

FY 17 witnessed the launch of 29 new funds (with more than 2,000 funds already present, as if the industry really needed more of them!). Investors unsuspectingly committed a tad more than Rs 4,000 crore to them. While some NFO’s (such as close ended Fixed Maturity Plans) are launched for legitimate reasons, one could question the rationale behind launching equity oriented NFO’s after markets have already seen a significant run up.

Would it not make more sense to launch NFO’s during bearish markets, pick up hammered stocks at bargain basement prices (albeit with sizeably smaller AUM’s!) and use a track record of sound performance to garner more moneys as cycles begin to reverse?

The glory days of Mutual Fund NFO’s peaked during the heady bull run of 2007, which witnessed more than 50 new schemes getting launched within a single calendar year! Interestingly, a large number of these fund no longer exist today – having been redeemed, or merged with other schemes. Of the survivors, very few have managed to deliver even double digit annualized returns in the past decade.

And yet, the trend continues unabated. Financial markets, and consumers of Financial Products do have famously short-term memories, after all. Sir John Templeton’s famous advice that the four most dangerous words in investing are “this time its different” gets blithely tossed aside over and over again, as waves of optimism engulf the investment decision making process for most.

What’s the key driver of NFO’s, then? Mostly, it’s the fallacious belief that “low NAV means cheap”, and therefore, “Units at Rs 10 must be a pretty awesome deal”. However, seasoned investors know better – if low NAV was indeed cheap, wouldn’t all NFO’s launched in 2007 have outperformed their higher NAV peers within the same category? Alas! That isn’t the case. Fact is – two funds with identical holdings and expenses will perform exactly the same, returns-wise, regardless of their NAV being Rs 10 or Rs 100. It’s the movement in their underlying securities that create percentage returns.

In fact, the promotion and marketing expenses associated with NFO’s can spike their expense ratios in the medium term, affecting their performance negatively in the process. Also, worth noting that NFO’s are rarely, if ever, launched in beaten down sectors which have the potential to go up. After all, it’s the “hot”, headline grabbing themes that grab eyeballs – and therefore hold the potential to become “big” NFO’s for AMC’s.

Smart investors should shy away from NFO’s at this time, instead electing to invest into seasoned funds with long term performance track records. To add another dash of prudence into the mix, make a staggered entry via 6-12 month STP’s (Systematic Transfer Plans).