A known devil is better than an unknown one. True? One wonders why this rule shouldn't be applied to mutual funds. Fund investors appear to be fascinated with the idea of investing in new schemes.
And fund companies are not complaining either. They couldn't care less whether you invest in an existing scheme or a new scheme, as long as you are willing to give them some of your money to manage.
Over the past six months 14 funds have been launched and these funds have so far collected Rs 3,878 crore (Rs 38.78 billion). The sales in existing schemes pale in comparison.
For instance, in February, the three newly launched equity funds -- Kotak Mid-cap, Reliance Index and Sundaram SMILE -- collected Rs 958 crore (Rs 9.58 billion) while fresh sales in the 139 ongoing open-end equity schemes amounted to Rs 2,222 crore (Rs 22.22 billion).
Even worse, while total sales in existing schemes amounted to Rs 3,180 crore (Rs 31.8 billion), redemptions in them were Rs 3,406 crore (Rs 34.06 billion). Fund salesmen say some part of this redemption is because investors are redeeming units from existing schemes to invest in new ones.
People invest in new funds for the allure of buying a fund at a par value or Rs 10. But this is meaningless. Why? When you buy an existing fund you are buying a portion of the assets that the fund possess or its portfolio.
If you invest Rs 10,000 in a fund whose net asset value is Rs 50 and the fund has a corpus of Rs 100 crore (Rs 1 billion) or two crore units (total assets/NAV). Assuming there is additional charge (load) for entering the fund, you will be allotted 200 units.
Since this is an existing scheme and would be fully invested in stocks, you are entitled to a share the gains that the fund makes though the fund manager may not have deployed your money in the market yet. The gains in the portfolio is not divided among 2 crore and 200 units. Also, if the inflows into the fund are not strong the fund manager can deploy your money in the markets.
Instead, when you buy a new fund you are asking the fund manager to invest your money in the hope that he buys the right stocks. "Usually fund managers take about three months to build portfolios depending upon the market situation and the fund size," says Suman Horo, chief manager, product research, Kotak Mahindra Bank.
Of course, there are some exceptions like the HDFC Core and Satellite Fund and Prudential Emerging Star Fund. HDFC Core collected about Rs 400 crore (Rs 4 billion) and managed to invest nearly three-forth of its mobilisation within a month. Pru Emerging also managed to do the same with a collection of Rs 196 crore (Rs 1.96 billion).
However, Tata Infrastructure Fund, which managed the highest mobilisation {Rs 750 crore (Rs 7.5 billion)} in an open-end equity fund ever (now, Franklin Flexi-cap has broken that record) during its IPO in December, still had about 38 per cent in cash at the end of February. The larger the collection the longer it would take to deploy funds.
So in a new fund, the gain will start kicking in only when the portfolio is fully invested. For instance, the Flexi-cap Fund, which collected a record Rs 2,000 crore last month, has invested only about a quarter of its total assets till now. In a rising market, an existing fund, which is fully invested in equities will do better than one which is not.
The reverse is also possible. Says Arpit Agarwal, head private banking, ICICI Bank, "the IPO investor may not always end up a loser. Someone who had invested in a new fund recently would be less hurt than an investor in an existing fund as the fall in the NAV of the former would have been less as the fund may not have deployed all its IPO proceeds just yet." But would you ever invest in an equity fund if you are expecting the markets to fall?
Most investors, however, do not seem to get this logic right. Says Agarwal, "investors have been led towards three things -- IPOs, dividends and par value." In short, investors do not understand the concept of rate of growth and that par value does not matter.
Most fund distributors have a list of about 10-15 asset management companies. New offerings from large AMCs with consistent record are on the preferred list. Sure, trusting your money to a fund manager who has a record is the right thing to do.
However, investing in a new fund as against an existing fund managed by the same manager may be foolish. Even more foolish will be to trust your money with a fund house which has not proved its worth in any of its existing schemes.
Does this mean that all new funds are bad? Not really. "Though we distribute all major new fund offerings, we recommend investor to look at thematic funds or newer kind of funds," says Horo.
Over the last few months Horo has been recommending Sundaram SMILE, Tata Infrastructure and Services Fund and JM Derivatives Fund. Each one has a unique proposition. Sundaram SMILE is the only fund, which invests in a small-cap stocks.
Tata Infrastructure was the second fund in the country to bet on the sector. The only fund, which came close to this was DSP ML Tiger Fund which invests in all sectors benefiting from the reforms process. JM Derivatives was a novel opportunity to gain from the arbitrage opportunity in the derivatives market.
There is caveat here. Thematic funds may be a good idea but funds focussed in a single sector may not be a great strategy. Sector funds are often launched when the sector is in favour. Few are launched in anticipation of a big move.
Adds Agarwal, "as markets tend to be cyclical it is unlikely that a particular sector will outperform year after year. So diversified funds may be a better option."
Also, in mature industries like banking or auto, the amount of value a fund manager can really add is limited. It is better to invest directly in stocks.
Besides, certain limitations with existing schemes managed by successful fund managers may make it difficult for them to replicate their past performance. That could be a reason to invest in a newly launched fund to be managed by a good fund manager.
For instance, Franklin Bluechip, which has outperformed the benchmark in 61 per cent of the times during its 11-year-long history and returned 30.22 (annualised), has a corpus of Rs 2,000 crore (Rs 20 billion).
Since the fund is positioned to take bets in stable large-cap stocks and restricts itself to investing in only about 30 stocks it may lose its maneuverability as its grows larger.
Says Horo, "funds with corpus of more than Rs 1,500 crore (Rs 15 billion) tend to lose their active management character. So it may be wiser to switch to a smaller fund managed by the same fund manager."
This argument may, however, stand defeated if the new fund also ends up with the same corpus. If you have invested in Franklin Flexi-cap Fund, the recently launched multi-cap diversified fund, you may be in for disappointment as the scheme ended up gathering a larger corpus.
But this may not be the case too often. Indeed, new funds are unknown devils. It may be necessary to give them their due sometimes.