New Fund Offers, or NFOs, as they are popularly referred to, have for some time now been a defining feature in the domestic mutual fund industry. The euphoria surrounding NFOs can be gauged by the fact that major offerings in the month of January 2006 amassed over Rs 8,000 crores (Rs 80 billion). So what is an NFO and should investors be investing in them?

What is an NFO?

Simply put, an NFO refers to a new mutual fund scheme from a fund house. With equity markets soaring to record highs, fund houses have tried to capitalise on the exuberance by launching a host of NFOs at regular intervals. In 2004, monthly income plans (MIPs) were the season's flavour, the same was replaced by mid cap and multi cap funds in 2005. At present close-ended funds, tax-saving funds and thematic funds are ruling the roost. Clearly NFOs have struck a chord with retail investors.

Should you invest in NFOs?

The answer to that question lies in a string of factors like the investor's risk appetite, his existing portfolio, the value proposition offered by the NFO and the fund house among others. Unlike an existing fund, which has a track record to show for, investing in an NFO would imply venturing into unchartered territory. The same could entail taking on higher risk.

As a result, investors need to lay even greater emphasis on factors like the fund house's investment style, the processes it follows (whether team-driven approach or fund manager-driven) and performance of like-natured schemes, before making an investment decision. One might rationally conclude from this discussion that investors are better off investing in existing schemes rather than NFOs. But despite this, why do NFOs find favour with investors?

The Rs 10 NAV

The Rs 10 net asset value (NAV) offered by new offers can be credited as a major driving factor. Investors tend to draw parallels between stocks and mutual funds while making an investment decision. The NFO's face value (Rs 10) is perceived as an 'inexpensive' buy; however, this premise is fundamentally flawed.

In a stock price, the book value (representing the stock's intrinsic worth) and the market price (wherein market sentiments and expectations are factored in) can be distinct from one another. For example, a stock trading at Rs 125 with a Rs 75 book value can be regarded as an expensive buy.

Conversely, in a mutual fund, the NAV represents the total assets held by the scheme after expenses like marketing and fund management charges have been accounted for. So a higher NAV is simply indicative of a higher asset value. The dual structure of a book value and market value doesn't exist in mutual funds.

Investment advisors also play a part here. Thanks to the attractive commissions offered on NFO sales, they aggressively sell NFOs and at times even mislead investors by convincing them of the cheaper purchase price.

Thematic offerings

Another grouse we have with many of the recent NFOs is their thematic/sectoral nature. Funds which invest only in the infrastructure sector or the services sector have a narrow investment objective and are typically high risk-high return investment propositions. An expert investor who understands the intricacies of the given sector and can time his entry and exit should ideally invest in a thematic fund. For the lay investor, a 'bread and butter' diversified equity fund is perhaps the best bet because it would anyway invest in sectors like infrastructure and services, for instance, if there is adequate growth potential.

However fund houses have launched a plethora of thematic funds and largely given conventional funds a cold shoulder. For instance, we are yet to see a single balanced fund NFO; a category that offers an attractive investment opportunity from the diversification perspective. This is despite the fact that some of the fund houses, which have recently launched NFOs, don't as yet have a balanced fund; but have plenty of thematic funds to show for.

Investors must realise that the core of their portfolio should be built from conventional funds that have a proven track record. Thematic funds can feature in the portfolio at a later stage.

Do they add value?

Another question that needs to be raised is -- does the NFO add value to your portfolio? Can it bring to your portfolio something that an existing fund can't? Personalfn's research team uncovered that a number of recently launched NFOs have portfolios that are strikingly similar to those of existing flagship schemes from the same fund house.

As stated earlier, if a sector presents an attractive investment opportunity, even a fund manager handling a diversified equity fund will invest in the same. Investing in a thematic NFO is not necessary to be a part of that growth story. On the other hand, during a downturn in markets, a diversified equity fund (with a broader stock and sector portfolio) is better equipped to curtail the investor's downside. The theme-based NFO would find itself grossly inept in such a scenario.

Should all NFOs be given a miss?

Not necessarily! Investors should participate in NFOs, but for the right reasons. An NFO which adds value to your portfolio should be considered. For example, an offering that is distinct from existing schemes and contributes towards building a comprehensive portfolio should be considered. However, if factors like a Rs 10 NAV are governing the investment decision; you are likely to be better off giving the NFO a miss.

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