The Mutual Fund merry go round

Which MF scheme should you invest in?

a) A Fund launched five years ago at Rs. 10 that has a NAV of Rs. 50 or
b) A New offering from the same fund at an entry price of Rs.10

To make your decision more “informed” assume that the new scheme will have the same investment pattern as the existing one, albeit packaged under a new name keeping with the latest flavour of the stock market.

In fact a “rational” investor should be totally indifferent between the two. The current NAV of the scheme is totally irrelevant!! If two funds have the same investment portfolio their performance will be no different.

Going by the enthusiastic responses to New Fund Offers (NFO) of various funds it seems that a large number of people believe otherwise. In fact a quick glance of the portfolios of some well known funds will tell you that they have multiple funds launched at different times, that have largely invested in the same set of companies.

Many mutual fund analysts have noted that despite the large funds garnered by New Fund Offerings the total amount invested in mutual funds has not increased significantly.

Clearly a number of investors are actually selling their investments in the fund quoting at a Rs 50 NAV to invest in the new fund offering at Rs. 10 because they believe the new fund is cheaper and therefore has more upside potential!!!

Who benefits?

The fund - because it is allowed to recover the marketing expenses from a new offering to the extent of 6% of the initial moneys garnered. To make matters worse this money is recovered over a five- year period effectively benefiting those who exit early and penalize those who stay with the fund.

Mutual Fund Distributors (in many cases banks) who make huge commissions by selling mutual funds.

The savvy large investor who “shares” the commission with his Agent

Who loses?

The poor retail “long term” investor who has not only incurred transaction costs for nothing, but has also effectively subsidized the Mutual Fund’s marketing expenses.

To put it bluntly this is nothing but a scam. Exploiting human irrationality and lack of appreciation of basic financial concepts amongst the masses to enrich themselves cannot be called anything else.

Authored by Sameer Nair