With the rising stock market, there has also been deluge of equity NFOs (New Fund Offers) from Mutual Fund Companies. This phenomenon is repeated every time the stock market starts running! The graph below shows the trend of equity NFOs from 2000. As you can see most NFOs are launched when the market is nearing its peak!
So there was multiple Equity based NFOs between August 2007 to June 2008. Similarly there were multiple NFOs between October 2014 to October 2015.
The reason is simple, mutual fund houses find it easier to sell NFOs when the stock markets are going up. The sentiment among retail investors is up and they can easily be sold the same old product with new names and new promises!
There have been a major change in the NFO launch – earlier most of the NFOs used to be open ended but now more than 60% of equity NFOs (in last 6 months) are closed ended. This change can be mainly attributed to new regulations by SEBI where in a Mutual Fund house cannot launch additional scheme which follows the mandate of an existing scheme. Also with the close ended fund the distributors could be paid more commission upfront (in most cases) and hence these funds are pushed more.
Closed ended Mutual Fund Schemes are those which can be redeemed from Mutual Fund houses only at the time of maturity. Also these funds can be bought only at the time of NFO. To provide early exit, they are listed on stock exchanges but the liquidity is so low that one cannot practically get out of these schemes.
Open ended mutual funds are those schemes where you can buy/redeem your investment with mutual fund companies on all working days.
Also Read: 13 Investments to Generate Regular Income
Theoretically speaking closed ended funds are supposed to do better due to following reasons:
But unfortunately most of the time these closed ended funds give returns similar to open-ended funds.
The Closed Ended Mutual fund has following limitations:
1. Market Timing
The major disadvantage of closed ended funds is that it’s linked to market timing. For e.g. if you had invested at the peak of the bull market in 2008 in an equity NFO maturing after 3 years; Your returns would definitely be negative and then you could not stay put in the fund for better days! So you have to forcefully book losses.
To reduce the market timing issue the recent NFOs have only dividend payout option where they would payout dividends as the funds books profits. I don’t think it’s a good idea mainly because dividends are rarely used productively. Do you remember what you did with the last dividend you received? Probably you might not have even noticed or spent it carelessly. To create long term wealth you should always subscribe to Growth option!
2. Low Liquidity
The next issue is of liquidity. You would not be able to redeem your fund before maturity. So the money is locked.
Also Read: How are Equity and Debt Mutual Funds Taxed?
Most people invest in NFOs due to their ignorance. Some of the reasons are:
1. No New Objective – If you care to read the Objective of any equity NFO – it says to invest in shares of good companies for capital gains in the long term. The wording may be different but it all wants to do the same thing i.e. select good companies to generate returns. The objective is same for existing mutual funds. So if there is nothing new in the offering “stay away”
2. No track record – if you talk to any expert about which mutual fund to invest, the advice is based on their past performance! Though past performance may not predict the future performance but that is the best you can do! This is true for most of the choices you make – for e.g while hiring someone you always want to know what he did in the past which does not guarantee success in future roles but that’s the best you can do! In fact the longer the performance record, the better it is. It can tell you how the fund performs in different market cycles. Also does the fund sticks to its mandate? What’s the funds expense ratio?
Also Read: Arbitrage Mutual Funds – A good Short Term investment option
Also Read: 23 most common Investments and how they are Taxed?
Most of the equity NFOs launched are beneficial for Mutual Fund Houses and their distributors. You should keep away from them until they offer some value to your existing portfolio. Before investing in NFO, always compare it with open-ended funds with longer track records!
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i think people should invest in Bank Deposit who earns annually less than 2.5L..I sure you will get more corpus than MFund. if you invest in best mutual fund it will give return 30% for 5 years and in bank 41% after 5 years. But surely and steadily you can gain more.