How did these NFOs fare?

The lure of the new fund offering goes beyond buying a mutual fund at 'par'. Screaming billboards, irritating bank executives, servile fund distributors and even your neighbour will mention every NFO often that you might start wondering if you will miss the bus if you don't apply.

Common sense and the wisdom of experts tell you that there is no great logic in buying NFOs, as they invest in shares that are available only at the prevailing market price, which any existing fund too can invest in.

But the high commissions to distributors, occasional pass-backs to investors and the attractive pricing of Rs 10 have made NFOs a major success in the past three years.

"There is a myth among investors that an NFO at Rs 10 is cheaper than an existing fund which is available at more than Rs 10. So the reason why investors are attracted to NFOs is more psychological rather than rational," says Paras Adenwala, chief investment officer, ING Vysya Mutual Fund.

As a result, more money has gone into NFOs than in existing schemes. In 2005, asset management companies raised over Rs 25,000 crore (Rs 250 billion) while the net inflows in existing schemes garnered less than Rs 22,000 crore (Rs 220 billion). Along the way, several AMCs kept making headlines for the highest collection ever for their NFOs.

Fund analysts suggest that investors should avoid NFOs and invest in schemes that have performed well over a reasonably good time period. Does this hold true for the NFOs that came in 2005? An analysis of all the NFOs of 2005 shows that 26 of the 40 diversified equity NFOs have underperformed their respective benchmarks.

No doubt, some of the NFOs have earned excellent returns as compared to their benchmarks. But several existing funds have provided even better returns in the same period. Then why are people investing more in NFOs and not in existing schemes?

"People are investing in NFOs because there has been product differentiation. Fund houses are coming up with innovative products, which is attracting the investors." says Mihir Vora, head of equities, ABN Amro Mutual Fund. This is true. We have seen a lot of AMCs expand their portfolios to include the products that they were missing, such as mid-cap funds, contrarian funds, or dividend yield funds.

But there were also the flavour-of-the-year funds like the flexi-cap fund or opportunities fund. Some sector and thematic funds focused on infrastructure, or services were also launched.

Of the 40 diversified equity schemes, Kotak Mid-Cap has been the best performing fund - it earned 102.94 per cent since its launch as compared to its benchmark Nifty Junior's return of 51.04 per cent. Magnum Midcap beat its benchmark CNX Midcap by 52.62 per cent.

Both funds, which were launched in the first quarter of 2005 benefited from the mid-cap rally that went on till September 2005.

At third place, ABN Amro Opportunities Fund outperformed the BSE 200 by almost 50 per cent. "ABN Amro Opportunities Fund is an aggressive fund with flexibility to switch across market caps and sectors. So, in this fund we have tried to capture the upside from all sides," says Vora.

Other funds that have beaten benchmarks include another opportunities fund and a mid-cap fund, and two flexi-cap funds.

The list of funds that have not matched the returns of the benchmark though is long. Most of the dividend yield funds have underperformed their respective benchmarks.

One fund manager who handles a dividend yield fund says, "One should not compare the performance of a dividend yield fund with the benchmark. In a dividend yield fund, we invest in companies having higher dividend yield and good business prospects, and there are hardly one or two companies from the benchmark that we invest in."

The ABN Amro Dividend Yield Fund has underperformed its benchmark by  62.97 per cent. "Not this particular fund but the entire category has not performed well. It is a value-oriented fund and for the last six months the market has been polarised towards growth funds and sectors," says Vora justifying the reason for the fund's underperformance.

Besides the dividend yield funds, some of the thematic funds have also been underperformers. "The Chola Global Advantage Fund is more of a thematic fund with the objective of investing in only those companies having 20 per cent of their turnover from outside India. In the past year, domestic economy-driven stocks have done well. So this fund has not performed so very well," explains Tridib Pathak, chief investment officer, Chola AMC.

Other thematic funds like JM Emerging Leaders investing in emerging companies that will become future leaders, or the Birla India GenNext Fund investing in companies that will benefit from the rising consumption patterns have lagged behind. Contra funds and services sector funds too have underperformed.

At the median of these 40 funds, there is underperformance of almost 7 per cent. Thus, if an investor had bought an NFO in 2005, the chances are more likely that he ended up with a fund, which underperformed its benchmark.