With Several New Fund Offers Doing the Rounds, Here’s How to Decide Which Mutual Fund to Pick

December 13, 2021 Mutual Fund

In 2018, SEBI had introduced categorization norms for mutual funds to prevent duplication of schemes and to ensure that schemes remain true to its investment mandate. This rule aimed to help investors make informed decisions, thereby making the mutual fund selection process easier for them.

However, the pace at which mutual fund houses are launching New Fund Offers (NFOs) raises question on whether they are helping the market regulator to meet its objective.

In the current calendar year, mutual fund houses have launched 176 schemes so far (around 14 schemes per month on an average). Even if we exclude Fixed Maturity Plans and Interval Funds from the list, there were 130 NFOs this year. This is by far the highest number of open-ended mutual fund schemes launched in any year.

These NFOs have collectively garnered a whopping Rs 75,695 crore, that too at a time when many of the existing schemes have been struggling to generate alpha over their benchmark. Several newly-launched and small-sized fund houses have also joined the bandwagon. Many more NFOs are lined up for launch in 2022.

Graph 1: Category wise number of NFO launches during the year 2021

Data as on December 10, 2021
(Source: ACE MF, PersonalFN Research)  

Why are Mutual Fund houses launching so many NFOs?

Equity mutual funds had witnessed massive outflows in 2020, amid turbulence caused by the pandemic. This trend has now reversed and equity markets have scaled record highs. It appears that mutual funds have taken advantage of this optimism in the equity market to launch new products and plug the gap in existing product range. Notably, investors tend to enter the market during uptrend buoyed by improving returns. This has led to huge inflows in NFOs.

Moreover, with a significant number of actively managed mutual funds finding it increasingly difficult to generate sustainable alpha over their respective benchmark indices, mutual fund houses have turned their focus on passively managed funds as well as innovative products to lure investors.

Unlike other categories, there is no cap on the number of Index Funds, ETFs, Fund of Funds, Sector/Thematic Funds, as well as Close-ended schemes that a mutual fund house can launch. Consequently, these categories witnessed the most number of launches during the year. Many mutual fund houses have found the opportunity in these categories to garner more AUM. Furthermore, since most of these are passively managed, there is no pressure on the fund management team to outperform the peers and the benchmark.

Graph 2: AMC wise number of NFO launches during the year 2021

Data as on December 10, 2021
(Source: ACE MF, PersonalFN Research)  

Should you invest in NFOs? And what should you keep in mind if you invest in NFO?

While the NFOs have presented investors with ample choices to select from, at the same time it has added to the confusion. The plethora of launches can make it difficult for you to select the best and most suitable schemes for the portfolio.

Often investors tend to invest in NFOs because it is generally launched at an NAV of Rs 10. This creates an impression that the new fund is available at a bargain price compared to older funds that usually have higher NAVs.

But this is not true!

Consider this, say you have invested Rs 5,000 each in two Large-cap Funds that have similar portfolios. Fund A has a NAV of Rs 10 and Fund B has a NAV of Rs 50. When you invest Rs 5,000, you will be allotted 500 units of Fund A and 100 units of Fund B.

Let’s assume after 1 year both funds have grown by 25%.

The NAV of Fund A will be 12.5, and NAV of Fund B will be 62.5.

The value of your investment will be:

Fund A: 500 units x Rs 12.5 = Rs 6,250

Fund B: 100 units x 62.5 = Rs 6,250.

Thus, both the funds have generated similar returns irrespective of the NAV.Therefore, you should not fall for ‘Rs 10 NAV’ proposition of new fund offers.

Track record of performance and risk-reward matrix is an important criteria to select the best mutual fund schemes. But since NFOs do not have a proven track record, it becomes difficult for investors to compare and pick the right scheme within a particular category. This makes investing in new fund offers a risky proposition.

Moreover, there is no reliable track record of portfolio characteristics such as asset allocation, market cap bias, sector allocation, rating allocation (in case of debt mutual funds), portfolio churning, portfolio concentration, etc. that can help you to understand the risk involved and make an informed decision.

Furthermore, when you invest in a scheme launched by a new fund house, it can be difficult to assess the investment philosophy and investment process that the fund house will follow. Remember, only process-driven fund houses that focus on quality and risk management can give you consistent performers over the long term.

[Read: How to Select Top Equity Mutual Funds for Your Portfolio]

That said, if you are willing to take the risk, you may consider adding NFOs to your portfolio provided they offer a unique proposition that is currently not available in the market and also if it can aid in diversification of your portfolio. The scheme should be suitable for your risk appetite and investment horizon and must enable you to realise your set financial goals.

If you are looking to invest in passively managed schemes you need to assess track record of expense ratio, tracking error, higher trading volumes (for ETFs) before investing in it. Additionally, ensure that the passive scheme is in sync with your overall strategic asset allocation.

You can also consider investing up to 15-20% of your portfolio in overseas passive funds that track indices such as Nasdaq 100, S&P 500, etc. to benefit from geographical diversification.

But apart from this, NFOs of Sector/Thematic Funds as well as innovative and emerging themes such as Business Cycle, Electric Vehicle, Blockchain Technology, etc. may not be suitable for the portfolio of most investors. If you decide to invest in these funds ensure that the overall allocation does not exceed 10-15% of your equity fund portfolio.

Things to remember

As an investor you do not need more than 5-10 mutual fund schemes in your portfolio, depending on the size of the portfolio. These would include schemes across equity mutual funds, debt mutual funds, hybrid mutual funds, and ELSS category. Remember that “Too much of anything is good for nothing”. This means that beyond a point, adding funds can lead to over-diversification. It also makes it challenging for you to manage and review your portfolio.

Instead of adding too many NFOs to your portfolio, follow a goal-based investment approach. This approach maps your mutual fund investment to a fixed financial goal such as your Retirement, Children’s Future, etc. You can invest in different categories and sub-categories of mutual funds based on your risk profile and time horizon to the goal.

[Read: Holding Too Many Mutual Funds? Here’s How You Can Reduce the Number of Schemes in Your Portfolio]

Ideally, if you have long term investment horizon of at least 5 years, your Core portfolio should consist of actively-managed equity schemes such as, Large-cap Fund, Flexi-cap Fund, and Mid-cap Fund. Choose schemes that have a long term track record of generating reasonable risk-adjusted returns and also fares well on qualitative parameters.

Whether you invest in NFOs or existing schemes, ensure that you review the performance of your mutual fund portfolio periodically. Some schemes perform well over the short term, but it is important to assess a scheme’s performance over the long term to determine its worthiness.

In my view, if your existing portfolio is well-diversified to ride the ups and downs in the market, you should stick to it instead of aimlessly adding new funds.

This article first appeared on PersonalFN here