New fund frenzy: Why ₹10 NAV isn’t the steal you think it is, says Rahul Bhutoria of Valtrust

With a record-breaking 231 new fund offers (NFOs) in 2024, raising over ₹1 lakh crore, passive investing is taking centre stage. Are fund houses riding the wave responsibly, or are investors getting caught in the hype? Rahul Bhutoria, Director and Co-Founder of Valtrust, in an interview with Fortune India, decodes the NFO frenzy, the dominance of sectoral and thematic funds, and the pitfalls investors must avoid.

Edited Excerpt:

Q: 2024 had a record number of NFOs even crossing 200 marks. Passive space seems to offer unlimited scope for launching new funds. Is this one way for fund houses to ride on the popularity of passive funds and capture market share?

A: In 2024, there were around 231 new schemes in the market, which raised over ₹1 lakh crore. This was a record year for mutual fund launches. Of these, 76 were index funds, showcasing the growing trend of passive investing. Fund houses are indeed leveraging this popularity to expand their offerings. Launching an index fund or ETF is simpler as it mirrors the underlying index, reducing dependence on fund managers.

Passive funds align with themes and trends, allowing fund houses to tap into specific market opportunities efficiently. Moreover, these funds meet investor demand for cost-effective, automated portfolio management. Thematic and sectoral funds were the most popular choice for investors. Themes like India opportunity, manufacturing, and digital were in high demand.

Q: Despite NFOs lacking performance track record why do investors succumb to hard selling tactics?

A: NFOs are frequently marketed as offering innovative strategies or tapping into emerging trends, creating excitement about being part of a "new opportunity." Many investors mistakenly believe that buying into an NFO at its initial Net Asset Value (NAV) of ₹10 is a bargain compared to existing funds, ignoring that NAV is irrelevant in assessing a fund's value or potential returns.

Investors often rely on the recent success of a sector to guide their decisions, assuming that past trends will continue indefinitely. This bias blinds investors to the inherent risks, particularly in sectoral or thematic NFOs, leading them to focus only on potential gains while ignoring the possibility of underperformance.

Moreover, investors also feel that they can time their entry and exit into the sector. Of the Sectoral/Thematic Funds whose data is available, about 60% of the funds have underperformed the Nifty 50.

Q: What is the ground reason for the increasing popularity of passive funds?

A: Passive funds are gaining traction for their simplicity and cost-efficiency. They track an index, rebalancing automatically based on its methodology. Passive funds have minimal management fees compared to active funds. With passive investing, there is no need to evaluate fund manager performance or pick individual stocks.

Sectoral index funds, for instance, allow investors to bet on an entire sector rather than specific stocks. For fund houses, passive funds diversify their offerings and attract a wider investor base without requiring extensive management expertise.

Q: What has been the contribution of sectoral and thematic funds to the NFOs in 2024?

A: About 124 new equity funds were launched in 2024, these funds have an AUM of approx. ₹1.4 lakh cores. However, 107 of these were Sectoral and thematic funds which have reached an AUM of approx. ₹1.04 lakhs crore.

Sectoral and thematic funds: More than 50 active sectoral and thematic schemes were launched that collected ₹80,000 Crores. Interestingly there were 53 Index and ETFs sectoral funds that were launched, which is almost the same as active. The index funds have increased from 7 in 2022 to 33 in 2024.

Q: Why does sectoral space have this aggressive number of NFOs, despite sectoral funds carrying the additional risk of being very narrow, and even being limited to one or two sectors with a small number of stocks for the bulk of the portfolio?

A: Sectoral and thematic funds are typically launched during favourable market conditions or sector peaks. This aggressive approach stems from positive investor sentiment during sector rallies and The appeal of high potential returns, despite increased risks from a narrow focus. However, investors should be cautious since Sectoral funds are highly cyclical and require timely entry and exit. These are higher risks and need to be invested and exited carefully. Only 54 sectoral/thematic funds are active, there are 33 index funds and 20 ETFs.

It’s interesting to note that while the active funds do have larger AUM the number of index funds is increasing. As more inflows come into the Index fund it will buy the stocks in the underlying index which may impact the price.

Q: The NFOs are launched despite the sectoral cycle reaching its peak. Are the AMCs not concerned about the performance of funds?

A: Sectoral and thematic NFOs often launch when a sector is trending, even if the cycle is near its peak. This strategy allows fund houses to capitalize on investor enthusiasm. However, the performance data tells a different story:

Of the 107 funds launched, the top 10 by AUM account for ~60% of the AUM of the funds that have NFO in 2024. From these top 10 – 9 are trading below their issue or launch price.

AMCs are manufacturers; they will want to be present in every sector. It is the investor who must take the investment call. 

Q: What are the investors expected to do in such a situation?

A: 1. A Core and Satellite approach can be taken

Core funds focus on funds diversified across market caps (multi-cap, flexi-cap) for long-term stability. Use systematic investment plans (SIPs) to manage risks and smoothen volatility.

Sectoral and thematic funds should be treated as short-term opportunities. Timing for both entry and exit is critical to capitalise on gains and avoid losses. Structural themes like banking and financial services may have longer-term potential. However, most sectoral funds demand close monitoring and quick decision-making. Balancing core and tactical strategies are crucial to managing risk and achieving growth.

2. Assess your existing portfolio's exposure to the sector or theme

Investors should first check if a particular sector is adequately covered in their portfolio through existing core funds. If not, they can take a tactical call to increase exposure to that sector by investing in specific sectoral or thematic funds. Investing in sectoral and thematic funds offers targeted growth and diversification, but concentration risks must be carefully considered.

3. If an investor is already invested in a sectoral or thematic fund, they should monitor drawdowns. Based on their risk appetite, they can decide on drawdown levels at which to exit or reduce their investment. This approach can be used to either book profits or cut losses.