When an investment firm (asset manager) plans to launch a new fund, it offers the public a chance to be the first to take part in the cash pool by investing in what is termed as a ‘new fund offer’, or an NFO.
The firm would collect money from investors first, and invest it on their behalf later.
It brings in investors by advertising benefits and offering more units in the fund (like shares in a company), after which the invested cash will then be used to buy securities (investable or tradable financial assets) for the investor.
Now that you understand what an NFO is, let’s go into the depth of whether you need to invest in an NFO, what all one needs to keep an eye out for and what to steer clear of when investing in them.
Are NFO investments vital?
With so many investment options available, it’s been widely recommended that betting on only one kind of investment is not the smartest thing to do. In contrast, you are advised to diversify your investments, meaning injecting cash in as many different types of investments.
If you have been investing for some time, another advice that you might often hear is that it is essential to ‘allocate funds in such a way that the risks are mitigated’. What this simply means is that if you incur a loss on one investment, you have room for profit on another.
Betting on only one kind of investment is not the smartest thing to do. In contrast, you are advised to diversify your investments, meaning injecting cash in as many different types of investments.
Such investors, who are constantly looking to diversify their portfolios, should consider investing in NFOs. Let us now find out how to invest and what the perks to investing in NFOs are.
IPO vs NFO
To clearly understand what an NFO is, you can compare with the workings of an initial public offering (IPO). A new fund offer (NFO), in working, is considered to be similar to an IPO. However, there are a few differences between the both.
Both IPO and NFO are similar as both represent attempts to raise capital to further operations of an entity (be it fund in one case and a company in the other). In an IPO, company shares are offered to the investors, whereas in an NFO, units of the fund will be offered to the investors.
• However similar they may seem to be, it is important to note that an IPO is quite different from a new fund offer. An IPO is the sale of a company’s shares prior to its listing on the stock market, whereas an NFO is a fund offering that doesn’t always give you the right of ownership (into the fund) or the benefit of a listing.
• Units you buy from an NFO have no real value; they derive value from equities, bonds, derivatives and other money market instruments. Stocks from an IPO have their own value. They signify your shareholding in a company.
• An IPO may be priced above or below the stock’s real value, which in the case of an NFO cannot be interpreted (a company’s market value is equivalent to a fund’s Net Asset Value). The pricing of a fund’s NFO is simply dictated by the market value of the units it holds, which is also known as the Net Asset Value or NAV. This is true during the time period of NFO and even after the fund is launched. So, while investing, you do not have to worry about IPO-like huge price fluctuations in an NFO.
An open-ended fund is officially launched after the NFO period ends. Investors can enter and exit the fund at any time after the launch of the offer.
On the other hand, a close-ended fund does not allow the entry and/or exit of investors after the NFO period, until its ‘maturity’ – which is typically 3 to 4 years from the launch date.
While open ended funds means the asset manager or funds manager can buy and sell various stocks according to their investment strategy, close ended funds usually deal in stocks of the same companies they began with.
Categories of NFOs
Broadly speaking, and particularly in India, you can buy NFOs in two categories as and when they are announced. As either mutual funds or exchange-traded funds.
Mutual Fund NFOs: These can be bought by any investor with a minimum INR 500 (Dh25) onwards, depending upon the fund manager and NFO offer. (Add link of previous story)
Exchange Traded Funds: Also known as ETFs, these are mutual funds that trade daily on the stock market. Anyone with minimum INR 5,000 (Dh250) can invest in ETFs. But you require a trading account to buy or sell ETF NFOs. Usually, they are on offer for a day or two only. (Add link of story done)
In India, investors may purchase an NFO unit of the mutual fund scheme at an offer price. This price is usually fixed at INR 10 (50 fils) per unit. Once the limited time period expires, the units of the fund can be purchased at an offer prevailing at that point in time (price is set by the fund manager).
Knowing the Net Asset Value
This would be the right time to brush upon what is an NAV and how does it relate to an NFO.
The NAV represents nothing but the value or worth of the entity (in this case the fund who’s NFO you are subscribing to) in the market.
First time fund investors are often confused about the concept of NAV of a fund scheme or an NFO. Most of them wonder whether they should buy into a fund with a higher or lower NAV. Financial advisors believe a higher or lower NAV is irrelevant to investors.
For example, suppose you are investing in two schemes with same portfolios. One scheme has been around for a while, so it has a higher NAV. The other scheme, a relatively younger one, has a lower NAV. This means, the investor would get more number of units in the scheme with lower NAV and less units in the scheme with the higher NAV.
The net asset value represents nothing but the value or worth of the entity (in this case the fund who’s NFO you are subscribing to) in the market.
However, both would get the same returns as the appreciation or deprecation of investment is the same as they have identical portfolios.
Pros and cons of investing in an NFO
Advantages
As NFOs are generally launched by a fund manager as continuation of its popular series or to introduce a newly themed fund, they come with the following benefits:
- Provides opportunity to invest with small budget in a theme such as tax savings or specific sector of the industry.
- NFOs are ideal if you will stay invested for long in a particular fund type. Hence, they are best suited for long-term investors.
- If you believe that a particular industry or sector will witness boom in the future and some fund managers launches that specific NFO, it provides you an investment opportunity.
- Generally, prices of units bought during NFO are bound to rise at least marginally at the end of a lock-up period (differs with each fund when you aren’t allowed to take a payout for an agreed period of time), even if they drop during stock market downturns.
Disadvantages
NFOs also come with their fair share of problems that you may be unaware of at the time of investing. Here are some disadvantages of investing in NFOs:
- Fund managers charge an ‘exit load’ when you redeem fund investment units bought during an NFO. The charge does not apply only if the NFO is continuation of a series of existing funds.
- Generally, most NFOs come with a lock-in period. Meaning, you cannot redeem their units or a payout before six months to a year.
- There are no guarantees that an NFO will develop into a profit making fund. There are no past records to prove its performance.
- NFOs are not rated by any credit rankings agency. So, how the particular fund manager handles the fund is anybody’s guess.
- Large financial scams can send prices of funds you bought as NFO into a tailspin. If the NFO has equities in the scam tainted fund, it might take years to recover from the loss.
How to invest in an NFO?
Investing in a new fund offer is a simple task. Investors generally find new fund offers a value-for-money proposition and hence subscribe to it.
- The first step that needs to be completed is your customer background forms (KYC documents include a recent photograph, PAN card, identity and address proof, a certified copy of the passport, overseas and permanent address).
- Once this is done, you may log in to your brokerage account (pertaining to the broker advertising the scheme) and check for suitable plans that suit your investment objectives.
NFOs help the investment companies meet their goals of driving up their assets under management. While investing in a new fund offer, it is suggested that you consider the following guidelines.
Guidelines for NFO investors
• Financial planners say investors should invest in an NFO only if it has something different to offer, which cannot be achieved through a fund that already exists and is active.
• Investors can subscribe to an NFO only within a limited time period; hence, NFOs are functional on first-come-first serve basis.
• Keep a background check on the fund house. It must be ensured that the fund house you are investing in, has a substantial history of mutual fund investments.
• Asset allocation, risk involvement, returns expected, etc. are a few important checklist points to be considered before investing your money in an NFO. (This is essentially deciding what assets to invest in, how volatile are those assets, and what returns would you hope to get from them.)
• One must carefully go through the offer document and the investment process that the fund manager is going to follow. It is of utmost importance to keep yourself updated with what the fund manager is planning to do with your money.
• Since NFOs don’t have any performance history, it is not possible to track the fund’s performance. However, while investing, you must be able to keep an eye on your returns periodically. Keep an ideal figure (based on projections provided by the fund manager) of the expected returns and analyse your fund accordingly.
• The minimum subscription amount for an NFO is an important criteria for deciding which fund you may want to invest in. Generally, the minimum subscription amount ranges from INR 500 (Dh25) to INR 5000 (Dh250). However, how much you subscribe does not affect your returns.
• Some NFOs might even come with a lock-in period of around 3 to 5 years. You must be careful of the time period for which you want to keep your funds locked in and invest accordingly.
Risks of investing in an NFO
Absence of track record: During the NFO period, other than a broad idea about the scheme’s directive, investors have little clue about what will constitute its portfolio or if the fund can execute its objectives. In the absence of a track record, investors have to rely on the fund house’s overall performance record.
In that case, consider the NFO only if it addresses a specific gap in your portfolio. Otherwise investors should wait for the fund to prove its credentials.
During the NFO period, other than a broad idea about the scheme’s directive, investors have little clue about what will constitute its portfolio or if the fund can execute its objectives.
Keep an eye out for the charges: During the NFO period, the investor only has a rough idea about the maximum charges that will be levied by the scheme.
The actual total expense ratio (total charges) is disclosed only later. Newer funds initially charge a higher expense ratio as their starting funds is very small. As its asset base expands, the costs start coming down. Investors should be mindful of the higher cost burden.
Timing is key: An NFO is usually launched by a fund house to complete its product basket, or if there is a demand for a particular investment theme. The fund managers tend to launch newer funds and come out with ideas when that theme is ‘hot’ or trending in the market.
But the problem is that the funds are launched when the underlying theme is at its peak. If you invest at such a time, it may leave you with a sour taste and lower returns (as the popular market saying goes ‘every high must come down’). So try to ascertain the investment rationale for the theme and if it can hold sway or sustain gains over time.
NFOs are usually launched by a fund house to complete its product basket. The fund managers tend to launch newer funds and come out with ideas when that theme is ‘hot’ or trending in the market.
In short, when investing in sectoral or thematic offerings, investors should be mindful of timing. NFOs of mid- and small-cap funds may yield varying results depending on the time investor starts investing. So, it is important not to buy into the hype – wait it out if necessary.
Suitability of intentions: Any new fund scheme will spell out its mandate— how and where it will allocate its money.
While funds usually take a multi-cap approach— investing across large, mid- and small-cap stocks— there are an increasing number of funds now that take a ‘concentrated exposure’ approach (like when ‘focused funds’ invest in only up to 30 stocks at a time). In this case, each bet will have a significant impact on overall returns from the scheme.
The fund manager will have to adopt a selective stance, taking sizeable positions in most high conviction ideas. If the bets play out as expected, this approach can yield high returns. If the calls go wrong, however, it can severely dent the fund’s return profile.
