I've been bombarded recently with offers to get into new mutual funds with an initial subscription price of, say, $10 a share. Is there any advantage to getting in at the fixed initial price? I would have thought that the net asset value is the net asset value, regardless of when the shares are purchased. Also, how do the funds determine the initial NAV of $10 a share when nothing has been invested? -- Edward Cheng
It might give you a feeling of exclusivity to be among the first to invest in a new fund, but that's about all you'll get.
When a mutual fund company launches a new product, the fund may have a subscription period before it officially opens. Fund companies and distributors, notably
, use a period of roughly four to six weeks to raise assets for new funds before their actual start.
Often, firms will exclusively partner with Schwab for these subscription offerings to get access to Schwab's vast customer base. At the end of last year, for example,
offered a limited subscription period for its new
Global Life Sciences and
Global Technology funds before the two actually opened. Investors could buy shares from Janus or Schwab at an initial offering price of $10 each.
You'll often see that $10 figure. The $10 -- sometimes $20 -- price is an arbitrary, artificial number that just happens to look nice. A fund can just as easily start with any other number, but the $10 figure may allow an easier conversion of share gains and losses into percentages by the average investor.
During the subscription period, this share price doesn't change. A fund's net asset value, the dollar value of a single share, is based on the value of all the fund's holdings divided by the number of shares outstanding. Since the fund manager has not started investing the fund's assets yet, the share price won't move until there are underlying investments to go up and down. A fund company can sell shares at this temporarily static number because there are no investments to move the share price. When the fund opens, the net asset value will be calculated like that of any other open-end fund.
These subscription periods help fund companies build up publicity and assets for a new fund. This prelaunch asset building reduces or eliminates the requirement for seed money from the fund company and gives the new fund manager more money to invest at the launch. And the more assets a fund has, the lower the trading costs should be to each of its shareholders.
But, frankly, these subscription periods are more of a marketing gimmick than anything else. They are "most advantageous for the fund company and the fund distributor," says Andrew Guillette, a consultant at
, a research and consulting firm in Boston. "Investors can still purchase the fund on the first day of trading regardless of whether they bought it during the subscription period."
There are virtually no economic benefits for investors who buy during subscriptions. "There is no great treasure chest here for the investor," Guillette says. You would be buying into a fund that has no unrealized capital gains, but you should get the same benefit by buying when the fund is young -- after it has already opened.
One drawback: If you pony up your money at the beginning of a subscription offering, your assets might be inactive until the fund actually launches. Bill Belden, vice president for product management at
Stein Roe Mutual Funds
, says his firm will wait to cash a check until the end of the subscription period. But if you want to keep your money in the market, you might want to wait until later in a subscription period or after the fund launches to invest that cash.
These subscription offerings may look a bit like initial public offerings of stock at a glance. But there is no connection. "We try to distinguish the two," says Belden. The prices of so many IPOs soar in the first days of trading. But a scarcity of shares really drives that rapid rise, says Belden. However, the same thing will not happen with a mutual fund. An open-end fund has an unlimited number of shares, and its net asset value is calculated based on the value of the fund's investments, not supply and demand.
Perhaps there is some cachet and excitement to be being one of the first investors in an forthcoming fund. In that case, subscription offerings might be attractive to you. Also, some professionals champion the advantages of being in a small, flexible new fund.
But caution is usually a good idea when thinking about investing in a new fund, particularly when there is a new manager involved. A little prudence won't hurt, but haste might.
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