Ask these three questions before investing in an NFO

The last three years have seen the launch of more than 300 new equity and hybrid funds, collectively raising a mammoth Rs 1.64 lakh crore. The momentum continues unabated in 2024, with 16 new fund offerings (NFOs) in January alone.

Even though SEBI limits fund houses to offer just one fund per category, the latter has found a loophole: there is no restriction on the launch of passive funds. As a result, there has been a wave of NFOs in these two categories. In fact, 52 of the 55 new large-cap funds launched between 2021 and 2023 were passive funds (index funds, ETFs or Fund of Funds).

This surge in new fund launches triggers a crucial question for investors: how should one approach investing in NFOs, and more importantly, are they investable at all?

NFOs are not like IPOs
Unlike the excitement around initial public offerings (IPOs), where investors eye quick profits on listing gains, NFOs are far more prosaic and low-key. In the case of NFOs, investors purchase units at a standard price of Rs 10 each.

And this is where the misconception comes in.

Some investors mistakenly believe that the lower Net Asset Value (NAV) of Rs 10 during an NFO means the investment is cheaper. But that's far from the truth. The real measure of an investment's value is how well the underlying portfolio performs. In short, it depends on how the fund is managed.

NFO glut
If NFOs aren't really cheap, why are there so many NFOs?

NFOs usually mushroom during a soaring market, as this is when fund houses find it easier to get money from investors like you and me. By raising more money from NFOs, they boost their assets under management (AUM) and, as a result, earn higher management fees.

So, before getting swept up by the NFO mania, it's essential to consider these three questions:

Question 1: Is there anything new in the new fund?

Very rarely does a fund come out that can be billed as the best thing since sliced bread. But in most cases, you will find similar funds that already exist.

So, the first question you must ask yourself is, "What new does it add to your mutual fund portfolio?"

If not, give the NFO a wide berth. It's always advisable to choose a fund with an already proven track record.

You may consider investing in the fund only if it adds a new asset class to your portfolio. For example, if it is an international equity/bond fund, it genuinely offers you diversification. You can even see the past track performance if the underlying portfolio is an index.

Question 2: Does the new fund fulfil my investment needs?

Something new does not necessarily mean something useful. If you have already built a portfolio that sufficiently covers your investment needs, the new fund is avoidable.

Think of the mutual fund space as a supermarket. You don't need most of the products but marketing gimmicks, combined with other practices, constantly bring them to your attention so that you give in.

In short, reflect on the use case of the new fund for yourself. For instance, an NFO of an index-based target-maturity fund is only appropriate if your investment horizon aligns with the fund's maturity period.

Question 3: Are there existing funds following the same investment strategy?

There are three aspects to this question.

One, are there other funds with a similar investment strategy? If there are, opt for proven ones, as mentioned in Question 1.

Two, does the new fund follow an investment strategy that has a history of poor performance? If so, there's no point self-sabotaging your investment portfolio.

Three, has the new fund introduced a unique feature or a brand-new investment style? In this case, too, we suggest you monitor them for at least three years before adding them to your portfolio. While the new fund's pitch may seem attractive, it is always better to let the investment style be tested by the market first.

And there's data to back our claim. To determine whether NFOs perform better than existing funds, we looked at the funds that collected over Rs 1,500 crore and have been around for at least three years. Out of nine such funds, only three surpassed the average performance of their respective categories.

Our take

• Come to think of it, the idea of investing in a new fund is a resounding 'NO' 99 per cent of the time.
  
• Don't let the fear of missing out drive you to make hasty investment choices.
  
• Consider waiting for a fund to mature for at least three years to assess its performance before investing.
  
• NFOs often encourage lumpsum investments in equity. But avoid that, especially when markets are high. Instead, invest in equity through systematic investment plans (SIPs).

Also watch: Should you invest in IPOs?