The new, new thing? Or the old faithful?

A common feature of raging bull markets, such as we have been witness to in recent months, is a sharp rise in the number of new fund offers (NFOs). These NFOs typically seek to capitalise on the current themes that are keeping the market happy and invite investors to deploy their money. Many of these NFOs are of closed-end schemes by mutual funds, while some are of the open-ended variety.

Is investing in an NFO an optimal way of participating in the market? Not quite. Here’s why:

NFOs do not have a performance track record to judge them by. On the other hand, there are a large number of existing schemes from various mutual fund houses that have consistently delivered well in the past and are open for investment. Unless there is a compelling and unique selling point about an NFO, it is better to stick with funds that have a track record and a tested investment approach.

NFOs may make sense for investors if the investing theme is unique. That’s not the case with most NFOs, which also broadly bet on similar growth drivers as existing fund schemes. But some fund houses occasionally do come up with themes that are different. For instance, the recent DSP BlackRock Equal Nifty 50 Fund, which assigns equal weight to each stock in the Nifty 50 index. If such unique themes suit you, you could consider going in for such NFOs. Else, it’s better and safer to stay with existing schemes.

New fund schemes typically have higher expense ratios. This is primarily due to their small corpus. The expense ratio in NFOs is often close to the maximum permitted by the regulator SEBI. On the other hand, established fund schemes with larger corpuses have lower expense ratios. The lower the expense ratio, the better your returns.

NFOs, particularly the closed-end ones, start with disadvantages. That’s because the investment in a closed-end fund is locked in for a specified period — say, 3 years or 5 years or other specified periods. During this period, investors are not allowed to redeem their units with the fund house. Units of closed-end funds mandatorily get listed on the stock exchanges, providing an exit option for investors. But this is not really useful, given the poor liquidity for such units on the bourses.

So, investors are essentially stuck with closed-end funds until their maturity — at which point the units are redeemed by the fund house. An investor in such schemes has little choice about calling it quits in between if the fund underperforms. This flexibility is always there in open-ended schemes, which allow investors to buy from and sell units to the fund house on a continuous basis at the prevailing net asset values (NAVs).

The market may be booming today, but one can’t say where it will be on a specified maturity date, when the units of closed-end funds get redeemed. If there is a broad market downturn at that point in time, the fund’s value could also have taken a knock, even if the fund is otherwise well-managed. The default option on maturity in closed-end funds is redemption of proceeds, which subjects investors to considerably higher risk unlike with open-ended funds, where the investors can hold on to their units and ride out the rough times.

Some closed-end funds offer the option of switching redemption proceeds on maturity to other schemes offered by the same fund house. But often you must commit yourself to this option (and even the scheme you wish to switch into) right at the beginning, during the application process.

This means that investors have to choose a suitable scheme now that they expect will be performing well a few years later. That’s quite a tough ask. In any case, if a shift is on the cards, why not invest in an existing open-ended scheme now instead of a closed-end NFO?

All this may suggest that there is not as persuasive case for the small investor to invest in NFOs. It is probably prudent to leave them to institutions who can take big risks and proprietary trading desks of the fund houses. Once the scheme is established with a good track record to show, you can consider investing in it.

That said, certain NFOs may warrant your attention — particularly, those with unique themes. Even in these cases, go for open-ended schemes that give you the flexibility to exit if you are not happy with the performance. Avoid closed-end NFOs, especially those with run-of-the-mill themes.