- May 2014
- December 2013
, 04 Nov 2010
We often find people confused about the concept of a New Fund Offer (NFO) in mutual funds. A very common confusion is to compare it with Initial Public Offers (IPOs) of shares. Indeed, both these were called IPOs till not long ago, when the market regulator SEBI cracked down on the practice.
To understand this, it is necessary to be clear about mutual funds first. Let us take an analogy – shares are like different kinds of sweets available in the market. Mutual funds are packets that put together a set of different kinds of sweets, to make your enjoyable box. So individual stocks are different types of sweets, mutual funds are simply different kinds of packaging of the sweets already available.
It is crucial to understand this distinction. An NFO is therefore only a new packaging of the same set of sweets. If a packet consists of three sweets, each worth Rs.50, you would expect that it costs about Rs.150 (and maybe a little bit more to cover the costs of packaging). This Rs.150 is neither cheap nor expensive – it simply is the market value of the underlying sweets. Of course, another mutual fund may include an expensive sweet priced at Rs.100. Such a fund would have an NAV of Rs.250, which in itself is again neither cheap nor expensive. Thus, to think that an NFO is cheap because it is available at Rs.10 is a complete myth.
An IPO can be (though not necessarily) cheap. New sweets may be priced cheap initially to induce sales – similarly some stocks may enter the IPO market attractively priced. However, an NFO can never be cheap – it can only have the value of the stocks it contains. Thus, there is absolutely no rationale for a customer to go NFO shopping in general.
Why then is so much noise created around an NFO?
This actually goes back to the days when commissions paid to distributors and agents on NFOs were extremely high (~6% as against 2.5% for other funds). Thus, it created a whole ecosystem wherein funds would come out with NFOs from time to time, which were actually the same sweets packaged in different colours. Agents would sell these more aggressively for their own selfish motive. You would end up paying for him, through higher charges deducted from your units' NAV.
Today, fortunately, NFO commissions have been capped by SEBI, to an extent that NFO pushing is no longer prevalent in the market. But pushing or no pushing, having learnt the fundamental concept of an NFO, we hope you never invest in them!