Invest in Credit Risk Mutual Fund or not?

Mutual funds launch their schemes through a New Fund Offer (NFO). This is nothing but the initial period when a new fund is open for subscription for investors. Many investors equate this with an Initial Public Offer (IPO) of shares but the situation is completely different between them.

Mutual Fund par value

When it comes to equity shares, the value at which the shares are offered to the investors is very important. The value has to be compared to the potential worth of the company and this determines the performance of the shares after listing. The situation is different for an MF because it has no value of its own. The Net Asset Value (NAV) of an MF depends on the performance of the portfolio of a fund. This is why the par value of Rs 10 that is present for a NFO is no better or worse than the net asset value of some other fund that may be far higher.

Let us consider this with the help of a simple example. Consider an existing fund that has a net asset value of Rs 20. It has an existing portfolio of stocks as its holding. Now a new fund that comes with a new offer priced at Rs 10. For simplification let us assume that the new fund has the same portfolio as the existing fund. If the entire portfolio value moves up 10% then the new fund NAV will go to Rs 11 from Rs 10. The existing fund with the same portfolio will see its NAV go from Rs 20 to Rs 22.

As can be seen, the investor is earning the same percentage return from both the funds because the portfolio is behaving in a similar manner. This means that the net asset value has no impact on the kind of returns that the fund will generate. In fact, if the existing fund performs better, then the rise in its NAV will be more than what the new fund will witness.

Portfolio construction

This is the reason why the composition of the portfolio is the most important thing for an MF. This presents another difficulty for the investor when they are choosing a NFO. For an existing fund, a portfolio already exists. So, the investor can see the holdings and then make an estimation as to whether these have the potential to generate returns.

On the other hand, the NFO has no existing investment and no portfolio so the investor has nothing to base their expectation on. They have to wait for the fund manager to actually construct the portfolio and then see if this will actually work out well. This adds an element of uncertainty to the investment in a NFO.

Overall decision

The investor should base overall decision not on the value of the units because this has no impact on the kind of returns that they will get. Looking at the portfolio and the manner in which this will be managed is far more important to ensure that there is success going ahead. The percentage rise in the value is the factor to consider and hence this is what attention should be on.

(The writer is founder, Moneyeduschool)