August 15, 2022
Should you invest in New Fund Offer (NFO) from Mutual Funds?

Should you invest in New Fund Offer (NFO) from Mutual Funds?

What is New Fund Offer (NFO)?

New Fund Offer (NFO) is the first time subscription offered by Asset Management Companies (AMC) or mutual fund companies to the Public for a freshly and newly launched fund. A New Fund Offer is launched to raise capital in order to purchase the securities such as shares, government securities etc. from the market.

New Fund Offer is similar to the Initial Public Offer (IPO) floated by companies with an attempt to raise funds to meet its objectives from the public. The NFO is open for subscription for a stipulated period of time and after that investors can buy from market at prevailing NAV. Unlike Corporate IPOs which are available mostly at premium, NFOs are open for investment at a fixed NAV of ₹ 10 per unit to lure investors.

However, one should not jump directly just looking at the low NAV. There are several parameters which need to be assessed before taking a dip in the New Fund Offer.

No Proven Track Record of New Fund Offer

Existing open-ended mutual fund schemes have track record to assess and judge. But there is no such past-record available with NFO, even if you like the strategy behind the new fund offer, execution skills of fund manager needed to be tested over the time. So why not wait before hopping in?  However as the saying “past performance does not assure the future returns”, but something is better than nothing.

Recommended Read: Mutual Funds Investment Guide

Diversification aka Asset Allocation

In the prospectus, the New Fund Offer will give a brief detail about the allocation of the money i.e. where the money received will be parked such as in Multi-cap, large-cap, mid-cap or small-cap. One needs to identify whether the investment strategy of the New Fund offers matches with the investment style and financial goal of the investor or not. If the profile of the investor is conservative and the NFO invests largely in small-cap companies the investor should not subscribe to this NFO as the risk-appetite of the investor does not matches with strategy of NFO.

Cheaper as NAV is ₹ 10 per unit

NFOs are priced at a fixed NAV of ₹ 10 per unit and this low price attracts investors because they think that they can buy more units in NFO in comparison with the existing open-ended mutual fund scheme trading at higher NAV, which is entirely false. Suppose both, NFO with NAV of ₹ 10 per unit and existing scheme with NAV of ₹ 100 per unit, gives return of 15% in a year so the next year NAV of NFO would be ₹ 11.50 per unit and existing scheme would be ₹ 115 per unit. So the higher NAV is a result of age and past performance of the fund.

Timing of Launch

A fund house come up with the new offering either to complete its product offering or there is a demand from investors for a particular thematic investment option. New Fund Offers are generally floated when the market participants aka investors are in buying spree and the market seems to be rich. The fund managers grab this opportunity and float the new fund in the market. These NFOs are aggressively marketed by mutual fund companies to fascinate the investors and take the benefit the positive sentiments of the investors.

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Comparing with IPO

Generally, NFOs are compared to IPO which is not correct. Under IPO companies collect money to expand its operations and the growth results will directly increase the wealth of the investors while under NFO the money received is invested in the securities of the companies which may or may not use the same for growth. That’s why the IPOs are always priced at premium and comparing it with NAV of ₹ 10 per unit of NFO is totally incorrect.

Various Costs of New Fund Offer

During the NFO, there is no clarity about the expenses ratio or any other charges that will be imposed by the scheme. The cost at the beginning in NFO is usually higher as the corpus is low, with the rise in the Asset under Management expands the costs starts coming down lately.

Further, NFOs are marketed aggressively to lure the investors and the advertisement expenses are generally very high at the beginning which is adjusted against the NAV, thus results into lesser returns to the investors in NFOs than otherwise.

Words of Wisdom

Usually, NFO are subscribed only if they are offering something new which is not in the market and you portfolio is also missing the same, which is rare the case. So it’s advisable to avoid subscribing mutual fund scheme during NFO phase. Taste the waters only when the execution capabilities of the fund manager are proven and the funds become consistent performer.

Always remember Low NAV during NFO phase does not mean it cheaper than the existing open-ended mutual fund schemes, a quality fund should always be preferred whether its NAV is ₹ 10 per unit or ₹ 1,000 per unit.

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