With markets at a new high, the interest of the individual investor is at an all-time surge. But very few know how to home in on such opportunities. Mutual funds are coming out with NFOs to tap this new investor money. But there seems to be a lot of confusion as to what exactly an NFO is and what the differences between an IPO and an NFO are, and whether or not this route is a good investment option.
Most of the mutual funds are coming up with NFOs to raise capital and lure new investors. These funds allow new units to be issued to the public for the first time, similar to when companies issue shares in an IPO.
This article democratizes the NFO, explaining exactly what it is, its variants, similarities, and differences from IPOs, and the various pros and cons of investing in an NFO fund. By the end of this article, you will have a comprehensive overview of NFOs that can help you make better decisions.
What is a New Fund Offer (NFO)?
NFO stands for New Fund Offer. It is the offering of subscription, for the first time, by a new mutual fund to the general public. In various offered NFOs, mutual funds usually issue new fund units to investors at an initial price—probably fixed at Rs 10 per unit, similar to the subscription price of an IPO.
Types of New Fund Offer (NFO)
Basically, there are two kinds of NFOs: close-ended funds and open-ended funds.
Closed-end Funds:
A close-ended fund is the one in which a fixed corpus amount is raised during the NFO period. Once the subscription period is over, no new investments are added. These funds have fixed tenure, normally in the range of 3-5 years. The investors can’t withdraw their money before that period, although these funds are tradable on stock exchanges though liquidity is limited.
Open-ended Funds:
Open-ended funds have more flexibility. No maturity period is fixed, and an investor can invest or redeem his money at will. These funds are pretty liquid, and continuous buying and selling is allowed. Most of the NFOs available in the market are open-ended.
NFO vs. IPO: Similarities and Differences
Similarities with IPO
Description: Both NFOs and IPOs represent an initial offering to raise capital.
Fixed Subscription Price: As in the case of IPOs, there is a fixed subscription price in respect of NFOs usually at Rs 10 per unit.
Documentation: Just as IPO information is provided in the Draft Red Herring Prospectus (DRHP) and Red Herring Prospectus (RHP), NFO details are available in the Scheme Information Document (SID).
Differences with IPO
Track Record: Companies coming out with IPOs have some credible track record to their credit and also provide performance and valuation details. There is no past record of performance for NFOs; hence, they only conceptualize and strategize their fund.
Subscription Period: In the case of IPOs, there is a fixed subscription period of approximately 3 days. As regards NFOs, the duration runs a little longer, on an average of 10-15 days of subscription period.
Listing Gains: IPO investors expect some listing gains on the listing day or the first day when the stock gets listed and begins trading. In case of NFOs, such gains are absent. The NAV of the fund goes on increasing over a period as the fund manager’s investments take time to appreciate.
Key Information in NFOs
When considering an NFO, it is essential to review the Scheme Information Document (SID), which includes crucial information such as:
Riskometer: This is an indicative tool, showing the risk involved with the NFO; it will be highest for equity-heavy funds and least for liquid and equity funds.
Fund Allocation Limits: The SID defines the minimum and maximum limits on fund allocation across various asset classes. Thus, for an equity-oriented fund or scheme, for instance, the minimum might be stipulated at 80 per cent to equity.
Prohibited Investments: The SID clearly mentions the assets in which the investment shall not be made, such as in the instance of equity funds—derivatives.
Expense Ratio: The Total Expense Ratio (TER) is disclosed, indicating the expected costs associated with managing the fund. This affects the fund’s NAV.
It also provides information regarding exit loads and the benchmark index for performance comparison.
Advantages of Investing in NFOs
Inaccessible Innovative Strategies: Since most NFOs come with new or some innovative investment strategies, they are not often existing in available funds. For example, it may use a business cycle investment strategy or an international asset strategy.
Expert Management: Investors get to obtain from the experience of fund managers in managing the investments of the portfolio or the complexities in the market.
Diversification: NFOs allow investors to diversify into new themes or asset classes.
Lower Initial Investment: Most of the time, the initial amount of investment in an NFO is comparatively lower than that needed in other available investment opportunities, hence attracting more investors.
Cons of Investing in NFOs
Lack of Track Record: NFOs do not have any performance history, and therefore, evaluating the potential returns by the investor through past performance is hard.
Market Timing Risk: Many retail investors invest in NFOs during bull markets at high prices of the underlying assets, leading to a higher price for entry with potentially lower returns.
Limited Information: Unlike in the case of an IPO, only very limited information on future performance is given out under a NFO, making investment decisions still more difficult.
No Listing Gains: The investors in NFOs do not experience listing gains, as is seen with IPOs. The returns are realized over time as the investments of the fund grow.
Conclusion
An NFO can definitely be a very valuable part of your investment portfolio, as it exposes you to new and dynamic funds from seasoned professionals. However, given the lack of performance history and probable timing risks to the market, investors have to be cautious and assess properly their investment goals and risk tolerance before investing in an NFO.
Knowing the essences of NFOs, understanding their differences and similarities with IPOs, and weighing all their pros vs. cons will help you in deciding—with caution. With any new investment opportunity, research due diligence is a prerequisite.
