The above can be explained with a relatively easy example. Imagine yourself to be the captain of the Indian Hockey team, who has a really important decision to make. You need to select a player from your team for a really important role, and you have two options in front of you. On one hand, you have an experienced player with an excellent track record; while on the other, you have a new player with no former experience at all. But here is the twist.
The new player has been receiving a lot of media attention and is hyped to be the next big thing.
Which of the two would you pick?
Most of you would stick to the experienced player, and that is perhaps the right choice.
Now with the same scenario, imagine yourself to be a mutual fund investor instead. Only now, in place of the experienced batsman with a track record, you have a mutual fund to replace it with. And in place of the new player, you have an NFO instead. As an investor, which option makes more sense to you? Of course, the mutual fund that is tried and tested. Should an investor choose an NFO, the call would be purely based on the fund manager and/or the AMC.
A common mistake that investors do is look at an NFO in the same vein as that of a stock initial public offering. They overlook the very fundamental differences between the two. When it comes to stock, its price is determined by its supply and demand. On the other hand, the supply of a mutual fund unit is unlimited. This means that the demand for a fund does not affect the NAV of the fund. IPOs care listed at a premium because their demand often exceeds their supply. However, when it comes to a mutual fund, when required for investment, separate unite are created, which then cease to be at the time of redemption.
Investors need to understand that NFOs are mere marketing devices. AMCs use NFOs merely to create excitement in the market and thus push their funds. Instead, investors need to learn about the new fund on offer and invest later on once the fund is open for sale and repurchase continuously.
Multiple new equity schemes were launched in the previous year through NFOs. This is because these schemes are easy avenues to capture management fees and increase the asset base of the fund house.
Many specialized funds are floated now and then. These funds have their focus on particular trends, sectors, and themes. Though there is not much that is wrong with these special funds, they tend to take away the basic advantages that mutual fund investing offers. And this is the chance of not having to decide which sector or theme to invest in. In the case of diversified equity funds, the fund manager decides where to invest. However, when an investor invests in a special fund, the decision of choosing the sector/theme becomes his, which then increases the risk factor.
The verdict for NFOs is the same as that for diversified funds and specialized funds. Investors need to stay away from NFOs. Many existing funds have been able to prove their mettle, and investors should opt for them simply because these have a track record, whereas new funds do not. New funds might turn out to be great and might outperform others, just like a new player might be more successful than the experienced one. But then, investing and sports are different fields. There is a much higher risk involved, and the investor’s hard-earned money is at stake here. Thus, it only makes a lot more sense to be a bit more careful!