Inexpensive Fund Alert!

Equity markets (S&P BSE Sensex) on Monday, 18^th August 2014 closed at a fresh lifetime high at 26,390, so it’s no surprise that a slew of mutual funds will launch new fund offerings trying to entice the retail investor to invest more in equities and to push up their AUM. What always surprises me is the number of friends calling me up to enquire whether they should invest in an upcoming NFO. On enquiring as to why they would want to invest in the NFO, most of them tend to give this common answer-‘Since they would be getting the new fund offer at face value (typically at INR 10/unit) it is a lot cheaper than the existing mutual funds which are quoting at NAV’s which are a lot higher'. Investors who understand how a mutual fund works know this logic is ridiculous, but sadly there are a large number of investors who have fallen prey to this not so logical logic. In this article let me try and explain you this argument. For those who already understand this may not read any further.

Equity mutual funds are basically pass through instruments. Whatever money they collect they invest in shares on behalf of investors. Let us assume a new fund offer is launched at an NAV of INR 10/share. Let’s say an investor wants to invest INR 50000 in this mutual fund. His money will be collected by the fund and he will be issued 5000 units (Investment amount/NAV = no. of units). The fund after collecting this money will use it to buy equity shares as per its investment strategy from the market and construct a portfolio. Now instead of a new fund offer if you choose to invest in an existing fund with an NAV of INR 50. This fund also will collect your money and issue you 1000 units (INR 50000/50). The second fund will also invest the amount collected as per its investment strategy.

Say both the funds choose to invest in equity shares of the same company for their fund. Just because the new fund offer has an NAV of INR 10 does not mean he can buy it at a discount from the market, both of them will have to pay the same price. The money collected by the new fund will have to buy shares at the current market price, which the existing funds already reflect. The NAV of INR 10 is just an optical illusion because the fund started later than other funds. What matters is the underlying value of your total investment and not the NAV.

So what are things to look for in a new fund offer if NAV is irrelevant? They key question to ask is,
1. Does this new fund offer you something which the existing funds don’t?
2. Does it fit into your personal investment basket?

Say an investor has a portfolio primarily of funds investing in large cap stocks and would like a fund specifically focused to midcap and small cap stocks and a new fund offers comes along to complete this gap in his portfolio, an investor can surely look at the new fund offering. Investment strategy, expense ratios, fund manager experience and track record are all relevant questions to ask based on which a decision to invest or not to invest can be taken. But the last thing to look at would be its NAV... and it certainly is not cheap!

However you may contact your financial advisor before taking any investment related decision.


Data Source: Bloomberg

Above article is authored by Quantum.

View All