Mutual Funds are always considered as the best tool 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.
But have you ever wondered how these schemes come into existence? And the answer to this is through NFOs.
If you wish to invest in mutual funds, you must be aware of NFO. Investing in a mutual fund scheme during the NFO period could prove highly rewarding for the investor. In today’s post we will discuss what NFOs are, how they work, and their benefits.
What is NFO?
A New Fund Offer (NFO) is the first subscription of a mutual fund scheme offered by the asset management company (AMC) to the general public. It usually occurs when a new fund is launched and allows the fund house to raise capital for the purpose of purchasing securities such as bonds, equity shares, etc. Investors can subscribe to the new fund offer of the scheme only for a limited period.
During this period, investors can subscribe to the units of the mutual fund scheme at a special price known as the ‘offer price’, which usually is fixed at Rs.10. After the subscription period is over, investors can purchase the units of the scheme at the prevailing offer. NFOs have been found to achieve significant gains once they begin to trade publicly.
Types of Mutual Fund NFOs
NFO mutual funds are generally of two types-
After the NFO, an open-ended scheme is available for all the investors. The investors, including the NFO subscribers, can then add more units or redeem their purchased units anytime they like.
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 funds 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, you get 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 it after a few months. This negatively impacts the investment goals. But with NFOs, like close-ended NFO, there is a lock-in period for which you must remain invested. This makes investment more disciplined and also increases the returns potential.
Things to Consider before you invest in a New Fund Offer
- Reputation of the fund house
Before investing in a new fund offer, ensure that you do a background check of the investment firm that is going to manage the scheme. The fund house should have operated in the mutual fund industry for a period between 5 years and 10 years. Assess the performance delivered by the AMC over those years and invest only if it has a good track record. If you are not satisfied after doing a background check, you can choose not to invest in the NFO of that particular fund house and pick an NFO of a reputed fund house instead.
- Objectives of the fund
The investment objectives of the fund will give you information about where the assets will be allocated, what are the risk factors associated, liquidity, expected returns, etc. In simple words, you will have an idea about where your fund manager is going to invest your money. The objective of the fund will help you determine if the NFO is promising enough to fetch you optimal returns on your investment.
- Theme of the New Fund Offer
The mutual fund arena is flooded with around 1479 schemes (as of February,2022) and hence, you should invest in an NFO only if it has something unique to offer. Read the scheme information documents thoroughly to understand the theme of the fund. It may be preferable to invest in similar funds which have a visible performance track record
Investments in NFOs may be a risky affair as it is not possible to assess where your money will be invested, like in an existing fund where you can check for the 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, you will not be able to ascertain how the fund is going to perform.
NFOs do involve a certain risk but that does not mean that investing in them is a totally bad idea. Some NFOs can turn out to be winners and fetch you really good returns aiding you in wealth creation. Analyze the return aspect of the NFO if you are really interested in it. However, if you have already invested in the NFO, then it is advisable to review your investment once a quarter for the initial 3 years. Doing so will help you understand if the fund is performing well and if not, you can redeem the units and invest in some other fund.
- Investment horizon
Before you decide to invest in an NFO, do not forget to consider your investment horizon and objectives. Some NFOs may have a lock-in period applicable to them which means that you cannot redeem the units until the lock-in period is over. An exit load may also apply on redemption and hence, it is recommended that you do not invest in an NFO if your investment horizon does not align with the investment horizon of the scheme.
Another factor that you need 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 you do not lose a huge amount if for some reason, you wish 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 have been 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 Rs.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 case of NFOs while in an IPO, the usage of funds is significant.
Should you invest 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 Rs.10. Most people invest in NFOs to take advantage of the low prices of the units expecting to achieve significant capital gains when the market is at a peak. Many investors also subscribe to NFOs as they feel that NFOs are a value for investment proposition. Fund houses use NFOs for achieving their AUM (Assets Under Management) goals.
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Disclaimer: Any Advice or information in the post is general advice for education purpose only and is not responsible for generating any trading profits for anyone, please do not trade or invest based solely on this information