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Mutual funds are considered to be one of the most popular tools of investment for beginners. With the growing popularity of mutual funds in India in the last few years, the number of fund houses or asset management companies (AMC’s) has increased too. In short, the Indian market is flooded with different types of mutual fund schemes. Ever wondered how these schemes come into existence? The answer to this is through NFOs. If one wishes to invest in mutual funds, one must be aware of NFO. Investing in a mutual fund scheme during the NFO period could prove highly rewarding for the investor. Let us find out more.
Defining NFO
- A new fund offer (NFO) marks the initial subscription of a mutual fund scheme offered by the asset management company (AMC) to the general public.
- Typically occurring with the launch of a new fund, NFOs enable the fund house to raise capital for purchasing securities like bonds and equity shares.
- Investors have a limited period to subscribe to the NFO units of the mutual fund scheme.
- During this period, units of the scheme are available at a special price known as the ‘offer price,’ often fixed at ₹10 per unit.
- Once the subscription period concludes, investors can purchase units of the scheme at the prevailing offer price.
- NFOs have demonstrated the potential for significant gains once they begin trading publicly.
Types of Mutual Fund NFOs
NFO mutual funds are generally of two types:
- Open-Ended: After the NFO, an open-ended scheme is available for all investors. The investors, including the NFO subscribers, can then add more units or redeem their purchased units anytime they like.
- Close-Ended: In close-ended schemes, NFO investors are not able to exit the fund even after the NFO period. These funds generally have a maturity period of 3-5 years, and investors can only exit after maturity. In theory, these funds can also be traded on stock exchanges even before maturity. But their liquidity on exchanges is generally very low.
Benefits of Investing in NFO
Generate Profits
Investing in a new fund offer of a mutual fund can be profitable as the units are purchased at a nominal rate. Once the units are traded in the open market, any increase in the NAV can substantially benefit the investors.
Invest in Innovative Funds
Many AMCs are now launching innovative mutual fund schemes. For instance, some schemes specifically invest in recently-listed stocks and IPOs. And some schemes use hedging strategies to generate better returns for the investors. With NFO, one gets to invest in such funds before it is open to every investor.
Lock-In Period for Disciplined Investing
A lot of people invest in mutual fund schemes only to redeem them after a few months. This negatively impacts the investment goals. But with NFOs, like close-ended NFOs, there is a lock-in period for which one must remain invested. This makes investment more disciplined and also increases the returns potential.
Things to Consider Before Investing in NFO
Reputation of the Fund House
Before investing in a new fund offer, ensure to conduct a background check of the investment firm managing the scheme. Look for a fund house with at least 5 to 10 years of experience in the mutual fund industry and assess its performance track record over that period. If unsatisfied, opt not to invest in the NFO of that particular fund house and consider an NFO from a reputed fund house instead.
Objectives of the Fund
The investment objectives of the fund provide information about asset allocation, associated risk factors, liquidity, expected returns, etc. In essence, they give insight into where the fund manager plans to invest one’s money. Assessing the fund’s objective helps determine if the NFO offers promising potential for optimal returns on investment.
Theme of the New Fund Offer
The mutual fund arena boasts around 1479 schemes (as of February 2022), so consider investing in an NFO only if it offers something unique. Thoroughly read the scheme information documents to grasp the fund’s theme. It might be wise to invest in similar funds with a visible performance track record.
Risks
Investments in NFOs may be a risky affair as it is not possible to assess where one’s money will be invested, like in an existing fund where one can check for asset allocation. This is because, in an NFO, allocation of funds cannot be done until the entire money is collected. NFOs also do not have a performance history and hence, one’s will not be able to ascertain how the fund is going to perform.
Returns
NFOs do involve a certain risk, but that doesn’t imply investing in them is entirely unfavourable. Some NFOs can yield excellent returns, contributing to wealth creation. Analysing the return aspect of the NFO is advisable if genuinely interested. However, for those already invested, reviewing the investment quarterly for the initial 3 years is recommended. This practice helps assess the fund’s performance, enabling investors to redeem units if necessary and explore alternative investments.
Investment Horizon
Before deciding to invest in an NFO, consider the investment horizon and objectives. Some NFOs may have a lock-in period, during which one cannot redeem units. An exit load may also apply on redemption, so it’s advisable not to invest if one’s horizon doesn’t align with the schemes.
Cost
Another factor that one needs to consider before investing in an NFO is the expense ratio. Opt for the NFO if it offers a lower expense ratio than an existing fund having the same investment objectives. Also, check for the exit load charged by the NFO so that one does not lose a huge amount if, for some reason, one wishes to withdraw from the scheme before the maturity date.
Difference between an NFO and IPO
Both IPOs and NFOs are launched to raise capital from the public but the difference between them is that IPOs concern equities of firms while NFOs concern units of a mutual fund scheme. The other differences between NFOs and IPOs are given below:
- NFOs are open for subscription for a longer duration as compared to an IPO.
- NFOs have no classification whereas IPOs are divided into institutional, retail, and HNI categories and a separate quota is allotted to each of them.
- NFOs generally open for subscription with an NAV not more than ₹10 and the fund allocates money for the purchase of shares only once the funds have been collected by the fund house. However, in an IPO, premiums or discounts are listed to the issue price based on the perception of institutional and retail investors.
- In NFOs, the price of the units does not matter but in an IPO, the price of the shares needs to command a better valuation since it will indicate the perceived value of the firm offering the IPO.
- The market level is significant in the case of NFOs while in an IPO, the usage of funds is significant.
Investing in a New Fund Offer
- In a new fund offer, investors can subscribe to the units of a mutual fund scheme for a fixed price of ₹10.
- Many investors opt for NFOs to capitalise on the low unit prices, anticipating significant capital gains when the market is at its peak.
- NFOs are also perceived as a value-for-investment proposition by some investors.
- Fund houses utilise NFOs to achieve their AUM (Assets Under Management) goals.
- Delve into the key differences between large, mid, and small cap funds in India to make informed investment decisions.
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Conclusion
NFO presents investors with an opportunity to subscribe to units of a mutual fund scheme at a fixed price, typically ₹10 per unit. Investors often view NFOs as a chance to capitalise on low unit prices and anticipate significant gains. Additionally, NFOs are perceived as a value-for-investment proposition by some, while fund houses utilise them to achieve their AUM objectives. Understanding the dynamics of NFOs equips investors to make informed decisions aligning with their investment goals and risk appetite.