New Funds : Are New MFs Worth Your Money?

While investing in equity NFOs in general may not be advisable, one can consider investing if an NFO offers a novel theme or exposure to a new asset class

Recently, a big fund house had to extend the closing date of its new fund offer (NFO) period due to poor response. And this is a trend that is quite visible in recent times. NFOs, which were earlier launched with much fanfare, have lost lot of their glam over the years, and especially in the last six months. This is reflected in the dwindling number of funds raised through NFOs.



The month of February 2019 saw one of the lowest money raised by the asset management companies (AMCs) through NFOs in the last 10 months. The case is far worse for equity dedicated mutual funds. In the month of February 2019, the total amount raised by equity dedicated mutual funds was Rs. 490 crore, which is lowest in the last 23 months and no equity close-ended funds were launched. Last time, we saw such numbers in the month of March 2017.



One of the major reasons for such dwindling inflows is the scraping of the upfront commission. The Securities and Exchange Board of India' (SEBI) in a circular dated October 22, 2018, introduced a slew of changes aimed at bringing transparency in expenses incurred by mutual fund houses, reducing portfolio churning and mis-selling. One of the changes was scrapping of upfront commission and following a full trail model for all schemes. This acted as a major dampener when it came to the NFOs. Besides, the volatile condition in equity market is also leading to lower interest of investors in NFOs.

Nonetheless, the recent numbers may be a like missing wood for the trees. If we see data for the last few years, we see that the year 2018 witnessed one of the highest money raised by AMCs through NFOs in the last several years.



The total amount raised through open-ended equity NFOs in calendar year 2018 was Rs. 12,692 crore, which is higher by 97% on a yearly basis, while the close-ended equity funds raised Rs. 11,701 crore, which is lower by 23% on a yearly basis. One of the reasons for such higher number of money raised in the year 2018 through NFOs is the implementation of the standardisation and re-categorisation of the schemes by mutual fund houses post the SEBI circular. According to the SEBI circular, fund houses clearly defined different categories of funds and a fund house cannot have more than one fund in each category.

Once the fund houses categorised their schemes based on the SEBI circular, they found various gaps where they were not present and hence they launched NFOs to fill those gap. For example, small-cap was one such category where various fund housed did not have any offerings. Hence, in the year 2018, there were three AMCs namely BOI AXA, Invesco India and Tata Mutual Fund that launched their small-cap funds to fill the vacuum. Similarly, there were four fund houses that came out with multi-cap NFOs last year.

Going ahead, we believe that the pace of launch of NFOs is going to decline. There are two factors that will lead to such a decline. First, there will be very few spaces left where fund houses can launch NFOs and, second, the returns generated by them do not seem to be exciting. So, if NFOs are launched, should you go for them?

The difference between NFO & IPO

When investors hear about NFO (New Fund Offer), they often confuse it with IPO (Initial Public Offer). Though the main intent of both is the same, i.e. to raise money from public, their purpose is different. When it comes to IPO, companies raise money to fund their businesses. However, the purpose of NFO is to collect money from public and invest them on their behalf in the stock markets, debt markets or money markets, depending upon the objective of the fund.

After the NFO is closed, the mutual fund invests the corpus raised from investors in the markets based on the scheme's objectives and investing style. The price or Net Asset Value (which is Rs 10 at the start) of the fund rises and falls based on its performance.

IPO is related to a particular company and NFO is related to a particular mutual fund. IPO is the perceived value of the company, as better-quality IPOs demand better price in the market. On the contrary, when it comes to NFOs, the price is not a concern. Rather the levels at which the funds enter the market matters. When it comes to investor's categorisation, IPO investors are categorised as retail, institutional and HNI (high networth individuals). Though, there is no such formal classification in the case of NFOs, the investors are usually divided into retail and HNIs.

The price of an IPO depends on its demand and supply, but in the case of NFO, there is endless supply. When it comes to an IPO, there is a lot of information available in the RHP (Red Herring Prospectus) such as the business the company is involved in, its financials, the purpose of the IPO, etc., based on which investors can make informed decision. However, the same is not true in the case of NFO, as apart from the SID (Scheme Information Document), investors do not have any such historical information about the fund as to where it is going to invest, how it has performed historically, etc.

Hence, never get confused between NFO and IPO and do not get lured by the NFO price of Rs 10 and do assess the suitability of the product in your scheme of things.

Should You Invest In NFOs?

It has been witnessed that NFOs are launched primarily when the markets are doing well. According to a study, the number of NFOs launched in the year 2017 were almost equal to the number of NFOs launched during the period 2009-13 when the market did not do well and was range-bound. The reason for such a phenomena is psychological. When the markets are trading higher, the share prices of most of the companies trade higher. Therefore, anything available at Rs. 10 looks cheaper and attractive. So, AMCs most of the time exploited this opportunity to raise funds. Nonetheless, is it important for you to understand whether investing in NFOs is beneficial and do not go by mere lower value of Rs. 10. (see : The difference between NFO & IPO)

To understand this we did a study of the entire open-ended equity dedicated mutual funds launched during 2014-18. NFOs of around 100 open-ended equity mutual funds were launched during the period and they managed to raise around Rs. 25,448 crore. The interesting part is that half of that amount was raised during last year alone. The category that saw the highest number of NFOs was large-cap, however, most of them were either ETFs or index based funds.



The Study

To know if investing in NFOs is overall good for an investor, we analysed the returns of all the NFOs launched between 2014 and 2018. The returns were analysed for the period of three months, six months, nine months and one year since the launch of the funds. Therefore, funds that had not completed one year were excluded from our study. These returns were compared against their benchmarks. The benchmark was selected based on the category of the funds. Therefore, if a fund was a small-cap dedicated fund, we compared its return against BSE Smallcap index, similarly for the other categories of funds, the appropriate benchmark was taken.

The Findings

Large-Cap Funds : In the large-cap category, there were very few funds launched during this period. The funds that were launched were mainly either exchange traded funds (ETFs) or index funds tracking some large-cap indices. Therefore, we could not make much study in this category. The reason for a lesser number of funds launched in this category may be because most of the AMCs already had large-cap dedicated funds in their stable or may be the fund houses saw opportunity in other categories since the market was in bullish phase.

Moreover, it has also been observed that there are only handful of large-cap dedicated funds that beat the market on a consistent basis, especially after the total return index (TRI) has been introduced to compare returns. Various studies have shown that large-cap dedicated funds rarely beat the indices in the longer run on a consistent basis. Hence, the number of large-cap funds launched was lower.

Mid-Cap Funds : There were three mid-cap funds launched during the period of our study that fulfilled our criteria of duration of existence of at least one year. For the first three months since the launch of the funds, on an average the funds underperformed their benchmarks. Nonetheless, in six months and onwards, mid-cap funds have outperformed their benchmarks on an average. Nonetheless, fund like IDBI Mid Cap fund has continued to underperform its benchmark since its launch in February 2017. As against this, there is also a fund like Mahindra Unnati Emerging Business Yojana that has been consistently beating the benchmark since its inception.

Performance comparison of mid-cap dedicated funds since their launch.



Small-Cap Funds

There were six small-cap funds that were launched during our study period, out of which five fulfilled our criteria. On an average, small-cap funds underperformed their benchmarks for the first three month since the launch of the fund, irrespective of the fund house or time when the fund was launched. For example, Union Small Cap Fund was launched in June 2014 when the markets were on a rage and were going up, yet the fund underperformed its benchmark in the first three months of its existence. Similar is the case with L&T Emerging Businesses Fund, which too underperformed during that time. Even if we extend the period, we find that till nine months after launch, they have underperformed their benchmarks. The performance is positive only after the funds completed one year.

Performance Comparison of small cap dedicated funds since their launch



Multi-cap Funds

These are funds are free to invest across market capitalisation. There were 15 funds launched in this category, however, only 12 funds fulfilled our criteria of existence of more than one year. The benchmark we took for multi-cap funds is BSE 500. Here, the performance has been mixed and depended on when the fund was launched. During the rising market, NFOs in the first three months of their launch beat their benchmarks. However, in the falling market, even the funds offered by best of the fund houses failed to outperform the benchmarks. However, in the longer run, they perform better than BSE 500. Performance comparison of multi cap dedicated funds since their launch

Performance comparison of multi cap dedicated funds since their launch.



Large & Mid-cap funds

This is a new category launched recently after the SEBI circular, hence there is no fund launched so far that fulfils our criteria. However, there were some existing funds that were launched earlier, but were not categorised in this category. Since, they were not launched under this category, we cannot analyse this category of funds.

NFOs of around 100 open-ended equity mutual funds were launched during 2014 to 2018 and they managed to raise around Rs 25,448 crore.

When Should You Invest In NFOs? 

Our study shows that NFOs should be avoided as they have higher expense ratios and no past record at all to gauge their performance. Nonetheless, NFOs should not be considered as untouchables. There are cases where it is advisable to invest in NFOs. 

Different Theme: If the NFO is offering a new investment idea or theme that goes along with your investment objective or overall financial plan, you can invest in it. If it is offering a niche that is not currently covered by the market, then you can take exposure to that theme. 

Complementing portfolio: If an NFO is launched that can give you access to new asset classes or investments that help you to either diversify your risk or add to your returns in ways that are not currently possible, you can look at such NFOs. Going through the scheme information document (SID) will help you to know all these and make right decision. 

Close-ended funds: Although there are various disadvantages' of investing in close-ended funds as they come with a lock-in period of 3 to 5 years, they can usually be bought only during the initial offer. If you find a close-ended NFO that fits your needs, you could opt for it.

Conclusion

The primary reason why an AMC comes out with NFO is to give investor an opportunity to diversify their portfolio in different categories. They want to fill the gap in their offerings. There are also cases where fund managers believe that the current situation throws up a good opportunity for a certain sector to make money for the investors. For example, if a certain sector or industry had gone through a very rough phase and is now going to recover, fund houses launch NFOs to take advantage of such an opportunity.

Nonetheless, before committing your fund to any such NFO, compare your existing portfolio and look whether you have any exposure already, and if you do, you can safely skip the fund. Even if it is a new theme where you do not have any exposure, you should assess its suitability based on your risk profile before investing.

We believe that giving a pass to NFOs is advisable in most of the cases. The reason being it takes almost 1-3 months to build a portfolio and, in most of the cases, even when the market is rising, the NFOs give negative return till then. Our analysis of all the main categories of funds clearly highlights that. Therefore, even if you want to invest in a NFO that suits your risk profile, you can always wait for three months, analyse its portfolio and then invest.

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