New fund offers, worth the money?

WE’RE all familiar with the phrase ‘Make hay while the sun shines’. Apparently the financial world is also familiar with it because that would explain the slew of mutual fund new fund offers (NFO) due to the buoyant mood of the markets.
And because we all love new things, investors have rushed to redeem their crores from a perfectly well performing existing fund to invest an NFO with similar objectives.

But how smart is that? Mutual Fund NFOs are nothing but commencement of a new scheme. They should not be confused with equity IPO usually get huge listing gain. There is no such upside on MF IPO’s. In fact there very well may be a downside. Lets look at it closely:

1. Ignorance is not bliss
One of the major reasons for the success of mutual fund NFOs has been the continued ignorance of an average investor with regards to the NAV. They have all along assumed that if they are getting the units at par ie Rs10, they are getting it cheap. Huge error!

NAV merely represents the market value of the portfolio. It is the book value. Thus when one invests in a mutual fund one is buying the units at the book value — which is Rs 10 for a NFO and could be Rs 15 or Rs 20 or whatever for an existing scheme.

The NAV of an existing scheme is higher merely for the fact that its portfolio has appreciated since the time it built it’s portfolio. Going forward, the returns over a given period of time will be same from an existing portfolio (with a higher NAV) and an identical new portfolio (with Rs 10 NAV). The earlier appreciation of the old fund does not make it expensive vis-à-vis an NFO.

2. Let’s talk numbers now
Say a fund (Old Fund) was launched in Sept 2004. It raised a corpus of Rs 1 crore and allotted 10 lakh units at Rs 10 each. The corpus of Rs 1 crore was invested equally ie. Rs 25 lakh each in Reliance, ONGC, Infosys and Arvind Mills. Over the next 1-year i.e. till Sept 05 all these share prices appreciated and the corpus became Rs 1.49 crores. Accordingly the NAV of Old Fund now is Rs 14.9608.

Now, assume that in Sept ‘05 a NFO is launched. It raises Rs 1 crore and allots 10 lakh units at Rs 10 each. It also invests in the same 4 shares viz. Reliance, ONGC, Infosys and Arvind Mills. The amount to be invested in a particular share is in the same % as in the Old Fund now (This is important, as we have to compare the impact of NAV on the returns and not the impact of the portfolio).

Now we invest Rs 10,000 each in Old Fund and NFO. In Old Fund, we get 668.414 units at Rs.14.9608/unit. And in NFO we get 1000 units at Rs 10/unit.

After one year in Sept 2006, due to appreciation in the share prices, the corpus of Old Fund increases to Rs 1.74 crores and NAV to 17.4669. And corpus of NFO increases to Rs 1.16 crores and NAV to 11.6751. But the investment value in both cases would have increased to Rs 11,675.

Author: Sanjay Matai
Source: Wealth, MoneyControl