NFOs: Should you invest in them?

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If you have been thinking of investing in mutual funds, you may have come across the term NFO or New Fund Offer. NFO is the first subscription offer when an investment company launches a new mutual fund in the market. The subscription is done at the base NAV of Rs. 10 for a limited period of time, which is currently a maximum of 30 days as per SEBI regulations. However, most AMC’s keep this period shorter at about two weeks in length.

Once the NFO closes, the mutual fund lists on the market within another 10 working day. After listing, it is once again available for subscription at NAV. NFO is a great option for investors as they get a chance to add units to their kitty at a very nominal price. Once the fund starts trading in the open market, it still takes about 3 months to deploy the collected amount and build it’s portfolio. Being part of the new fund especially in the first few months is beneficial as the fund is able to navigate per the current dynamics of the market and in a staggered manner.

Last financial year witnessed a surge in NFO collections, and in fact, it was 75 percent more than the last ten-year average of launches. Unfortunately, many investors wrongly assume that investing in NFOs is the same as investing in an IPO for equity. So let’s dive in and examine NFOs more closely so that you can learn why investing in them is different, albeit still a good option.

Types of NFOs

Most of the NFOs that create a buzz in the market are either in the equity or the hybrid categories. Within that too, there are two main categories:

Close-ended funds: Such funds only offer a specified number of units when a New Fund Offer is released. This means that the investors remain the same right from the beginning of the NFO until the end of the scheme. The period is typically 3-4 years. Once the time period is over, typically close ended funds mature and the amount is directly credited to investors with no decision to be made at their end. However, off late a lot of AMCs have started either merging a close ended fund with an existing open ended fund at maturity or simply converting the close-ended fund into open-ended fund with original funds getting an option to exit.

Since close-ended NFOs are for a longer duration, investors cannot give in to the itch of taking the action of redemption. Moreover, the fund managers do not face a liquidity pressure of needing to keep some amounts in cash for any urgent redemption requests. However, close ended funds which do not give investors an option on maturity do depend on market timing. If they mature at a time that valuations are depressed, the overall performance could pull down.

Open-ended funds: For such funds, investors are permitted to subscribe to the NFO before the determination of NAV with the assumption that it will start at a base level of Rs. 10 (which strangely enough is an attraction for many investors). They can trade the units on the market once the NFO gets listed and starts operating as any other fund.

Open-ended funds are more popular as there is no limit on the entry or exit of the investors. There is also no limitation on the amount of capital that can be raised from the investors. However, in case of sudden redemption pressures investors who continue to stay put can suffer short-term volatility. Also, as the popular funds keep growing, in some categories size can become a challenge making the fund movements sluggish.

What is in it for investors?

There are a couple of reasons why NFOs are a good option:

It is a great way to add variety to your investment portfolio, especially if the NFO introduces a mutual fund in a new sector. NFOs also start with a clean slate and don’t carry the baggage of past performance. For some investor, starting at NAV of Rs. 10 works very well in terms of mental accounting.

If the fund manager is a credible one with a good track record and the mutual fund pertains to a category that fits in well to your portfolio then it makes for a good option. This holds true especially for some categories which might still be in a dearth of options, for instance Multicap or even Balanced Advantage Funds.

But just like you don’t order every single item from a menu, it doesn’t make sense for everyone to invest in every NFO. A lot of NFOs might come in for an AMC to add their fund in an already crowded category. For instance, Flexicap is one of the oldest category and there is a high probability that you already have it in your portfolio with very little to be added by duplication of a NFO. It is also important to evaluate whether the NFO matches your investment objective, risk appetite, and asset allocation strategy.

Things to check before investing 

Like any other investment, you need to have a thorough understanding of NFOs before you start investing. Here are a few things you must take into account if you are planning to invest in NFOs:

USP: Given that mutual funds have become such an incredibly popular investment avenue, they are available dime a dozen. Due to the large number of mutual funds in the market, you may find it overwhelming to choose the right one. That’s why whenever there is a NFO announcement, check if the fund offers something unique which makes a strong case for you to invest your hard earned money. Only if the fund offers something better than what is available in the market will your investment feel financially rewarding.

The costs: Read the NFO document closely to identify the various costs associated as you don’t want a chunk of your investment money to go towards meeting unnecessary expenditures by the fund. Bear in mind that these costs vary for equity, debt, and index funds. Ideally, the total cost of the fund should go down as it grows. It is also a good idea to compare the prices of different fund houses, observe their track record, and then make a decision to invest.

Apart from the above, you should also take into account the historical performance of the fund house, the returns from similar funds that are already available in the market, lock-in period for close-ended funds, and the investment objective set out in the NFO document.

Investments in NFOs can be undertaken through a broker or your online trading account. But jump into investing in an NFO simply because everyone else is doing it. Remember that unlike existing mutual funds for which you can rely on the historical performance data, there is no past performance for NFOs you can look at. If you are a beginner or a risk-averse investor, selecting the right NFO for investment can be a daunting task.