How have new mutual funds fared?

A friend mentioned to me a while ago that she prefers investing in New Funds Offerings because "you only pay Rs 10 for the units."

The other day, after the bloodbath on Dalal Street, she commented she was horrified to see the Net Asset Value of a few of her mutual fund investments go below Rs 10.

Why are investors obsessed with the Rs 10 price per unit?

Let's deal with two common misconceptions.

• The biggest mistakes investors make

Myth 1: The units are cheaper

No, they are not. Just because a fund's NAV is Rs 10 and another is Rs 20, it does not mean one is cheaper than the other.

Let's say you invest in two funds: Fund A and Fund S.

In each fund, you invest Rs 10,000.

Fund A = Price per unit is Rs 10 per unit.

Fund S = Price per unit is Rs 40.

In Fund A, you will get 1,000 units and in Fund S, 250 units.

Now, let's assume the NAV goes up by 10% in both the cases.

So the Rs 10 unit will be Rs 11 (10% appreciation of Rs 10) and the Rs 40 unit will be Rs 44 (10% appreciation of Rs 40).

So, in each fund, the value of your investment has moved from Rs 10,000 to Rs 11,000. It did not matter that one was Rs 10 and the other Rs 40. Neither did it matter that you could buy 1,000 units in one fund and only 250 units in the other.

All that mattered was the total return on your initial investment.

• Mutual funds: 5 biggest losers

Myth 2: An NFO is just like an IPO

An NFO is a new fund offering (new mutual fund). An IPO is an initial primary offering (shares are listed on the stock exchange to buy and sell).

The two are different. You cannot treat a fund's unit like a share.

An IPO may be considered overvalued or undervalued. Depending on that, you can gauge whether or not you will be able to make a profit when the shares are listed.

This is not true in the case of a NFO. The NFO will use the money to buy stocks in the market at whatever price they are available. So the NAV will reflect the current market price of the stocks bought.

The value of a fund's NAV depends on what stocks the fund manager has invested in and what the current prices are.

• Choosing a stock? Understand annual results

NAVs can drop to 'below 10' levels

A few investors may not be aware of it but this is not a myth, it is reality.

Those aware may not believe it can actually happen.

Well, here's a surprise. Of the 21 equity funds launched this year, 19 have slipped below Rs 10.

Mutual fund research outfit Value Research looked at the period between May 10 and May 24, 2006. The BSE Sensex tumbled a little over 2,000 points or 16%. Check how some new funds fared during this time.   

The returns are between May 10 and May 24, 2006. The NAVs are as on May 24, 2006.  

But don't go and sell your units in panic. Hold on to them. Remember, these funds are linked to market performance and you will be able to reap the benefits only in the long run.