Read this before you choose an NFO

Suppose you must choose between an equity New Fund Offer (NFO) priced at ₹10 per unit and an existing fund whose net asset value (NAV) is ₹50. Which one would you prefer and why? In this article, we look at factors that you must be mindful of when you make such choices.

Track record?

The choice between an existing fund and an NFO will be easy if the NFO were offered by the same asset management company (AMC) with the same portfolio manager following the same investment strategy. Suffice it is to understand that the returns on both the funds will be similar. Suppose you invest ₹50,000 in the NFO and receive 5,000 units. A year later, suppose the NAV is ₹12. Your investment is worth ₹ 60,000, translating to a 20% return. If you were to choose the existing fund, you would have received only 1,000 units. A year later, its NAV could be around ₹60, also giving you a 20% return.

But real-world investments are far from simple. A recent SEBI proposal states certain conditions that AMCs must meet if they were to offer an NFO with the same strategy as their existing funds. So, often, you will be forced to compare an NFO from AMC 1 with an existing fund of the same strategy from AMC 2. You could argue that it is easy to evaluate an existing fund with a track record. Remember that alpha, the excess returns a portfolio generates over an appropriate benchmark, is a function of both skill and luck. And it is not easy to differentiate one from the other. So, how should you select between an NFO and an existing fund?

Conclusion

You should not be tempted to invest in an NFO because it is priced at ₹10 per unit. Instead, you should check if the fund is likely to overlap with your existing investments. The simplest way to do this is to check the NFO’s benchmark with the benchmark of the funds you currently hold in your portfolio. You will find the constituent stocks of these benchmarks on the NSE and the BSE websites.

If the overlap in the benchmark constituents is more than 50%, you should, perhaps, not invest in the NFO. If the overlap is minimal, consider whether the NFO will be in line with your investment objectives. If so, consider investing in the new fund.

(The author offers training programmes for individuals to manage their personal investments)