Many educated professionals have burnt their hands (suffered losses) investing in mutual funds. On my interaction with few of my professional friends on their past investments, I noticed that there were a few common patterns that went wrong with most of their investments. They were either victims of mis-selling or had invested at a time when the markets were in a frenzy!

For most of these investors, NFOs (New Fund Offers) were one of the highly mis-sold products, showcasing them as low cost investments.

My worry is that despite being educated, many investors believe NFOs give them the opportunity to invest at low cost. This prodded me to write an article to clear the misconception and check for myself if investing in NFOs was actually an opportunity or a trap for retail investors.

First, let us understand NFOs and discuss how an investor should deal with them.

What is an NFO?

A New Fund Offer (NFO) is the first time offer for subscription to a mutual fund scheme launched by an Asset Management Company (AMC). NFOs are offered by AMCs only for a stipulated period and are launched at a fixed per unit price (offer price) that is generally Rs 10 per unit. So, does buying NFOs mean buying cheap?

NFOs are Cheap! - The Biggest MYTH:

Most of the investors think NFOs are cheap as compared to the existing schemes with a higher NAV. Here's a simple example: let's say an AMC launches an NFO in equity diversified category at Rs. 10 per unit, and the same AMC also manages an equity diversified scheme whose current NAV is Rs. 20 per unit. Does this mean the NFO is cheaper than the existing scheme? It's a big NO. Remember, the money collected through NFO or an existing scheme is going to be used to allocate MF units for the amount you paid. The only difference in this example is, you will receive more units in the NFO as compared to the existing scheme, but that doesn't mean there would be any difference in returns.

The returns of a fund solely depends on the performance of the stocks the fund holds and not on the NAV price. Therefore, never consider low NAV as a reason to invest in NFO. 

Are NFOs launched only when the markets are euphoric?

By and large, we have seen most NFOs being launched when the markets are gung-ho. It is a common behaviour of most of the investors that they tend to enter in rising markets.

To study this, we considered last 10 year period for our analysis. During this period, the Indian markets have witnessed 5 years of euphoria (bull period) and 5 lull years (including both bear and flat market conditions). 

To keep our study focused, we analyzed NFOs that were launched under the open ended equity (diversified, large cap and mid/small cap) categories during this period.
 

From the above chart, we could deduce that 117 new funds were launched in last ten years, out of which 65% of the NFOs were launched when the markets were in euphoria! However, despite 2008 being a lull period (market tumbled around 62%) 14 NFOs still hit the market.

Post 2010, due to lull market conditions and SEBI's clampdown on new funds, there has been a decline in the NFO numbers.

NFOs Performance - Decoded:

The performance of the NFOs launched in last 10 years are disappointing. Just 42% of these funds have outperformed their category average.