NFO (New Fund Offer): What is NFO in Mutual Fund?

New Fund Offers (NFOs) from the mutual fund industry raised a little over Rs. 62,000 crore in 2022-23. Analysts saw this collection as “subdued”; there were two reasons why they were unimpressed.First, the collected amount was about 42% lower than that raised the preceding financial year, and second, more new schemes were launched during the year than in 2021-22.Analysts had an explanation for the lower NFO collections over FY23. According to them, it was primarily because of the ban the market regulator – the Securities and Exchange Board of India or SEBI – imposed on NFOs for the April-June quarter in 2022-23.The ban was put in place after a broking house was found to have illegally pledged investors’ funds as loans. This raises two immediate questions: What is NFO in mutual fund? Is it wise to invest in NFOs?In this blog, we will explore these questions and more. Also Read: SEBI’s Classification of Mutual Funds

NFOs are new schemes on offer from mutual funds for the public. The concept is similar to that of Initial Public Offerings (IPOs), as in both are aimed at raising money from investors.However, with NFOs, instead of shares, investors receive units as per their respective investments, but this happens after the subscription closes, and the total money raised is divided into units for allotment. Plus, with IPOs, investors buy a stake in the company, however small that maybe; this is not the case with NFO investors. (There are other differences, which have been discussed later in the blog).The Asset Management Companies (AMCs), which issue the NFOs, are required to spell out details like the kind securities the mutual fund will invest in, the type of companies it will seek out for investments, the fund manager who will handle it, etc.An AMC usually launches a new mutual fund if it thinks there will be a demand for that fund. For instance, after research, if it is found that most investors are interested in a combination of large-cap and small-cap equity, then the NFO is designed to appeal to that set of investors.NFOs of close-ended mutual fund schemes also let participants to invest in investment strategies that may not have been explored by existing mutual fund schemes. Also Read: What is NFO (New Fund Offer) And How It Works?

Under SEBI guidelines for NFOs, the minimum subscribed amount for hybrid funds and debt funds must be Rs. 20 crore, and that for other mutual fund schemes is Rs. 10 crore.That apart, mutual fund schemes at all times, are required to stick to what is known as the “20-25 rule”; under this rule, a scheme must have at least 20 investors, and none of them can have more than 25% of the scheme’s corpus.SEBI has also laid down guidelines on investment requirements on the AMC’s side. In mid-2021, it asked mutual fund houses to increase their investments in NFOs depending on the risk. In other words, fund houses must invest less in safer schemes like debt funds and more in risky schemes like equity funds.However, SEBI did not specify any minimum amount that the AMCs had to invest. Earlier, AMC investment used to be either Rs. 50 lakh or 1% of the amount raised, whichever was lower.This apart, an AMC cannot have more than one scheme in a particular mutual fund category. So if it already has a scheme in the large-caps category, it cannot come up with an NFO for another large-cap scheme.On their part, the NFOs usually lay down a minimum subscription amounts for investors, which can range from Rs. 500 to Rs 5,000. The unit price is usually Rs. 10, which means someone who has invested Rs 5,000 will be allotted 500 units.Under SEBI regulations, durations for NFOs of mutual funds cannot exceed 15 days. Usually, NFOs of equity funds are open for 15 days, while that of debt funds are for about three to four days.If an applicant is not allotted any unit of the new fund because of incomplete KYC details or other errors in the application forms, it is the AMC’s responsibility to refund that person.

Let’s start by looking at a few notable features that NFOs offer you:

Fresh investment

Because NFOs are launched when an AMC releases a new scheme, they give you a chance to invest in a brand-new opportunity.

Limited subscription period

If you want to subscribe to an NFO, you will have to do it within the specified time when the units are sold at the initial offering price. This period is set by the mutual fund house and typically lasts for a few days to a few weeks, depending on the fund's popularity and market conditions.

Goodwill of the fund house

NFOs are released at the initiation of a new scheme, making it impossible for investors to access a past record for the scheme. This is where the reputation of the AMC comes into play. You can choose whether or not to invest in an NFO based on the credibility and track record of the fund house.

Allotment

The fund house distributes units to investors based on their subscription amounts after the NFO subscription period has ended, and the NAV of these units is determined using the real market value of the underlying assets.

SIP investment option

Although not applicable to all, some NFOs provide their investors with the option to invest in the new scheme as a regular SIP once the scheme is listed.

At the beginning of this blog, we asked a question: Is it wise to invest in NFOs? This brings us to the advantages and disadvantages of NFO investments; let us start with the benefits, listed below:

High returns

Returns can be higher if the investment is over the long-term, as in for close-ended funds. The lock-in period also instils financial discipline among investors, who may be tempted to exit quickly if they find the difference between the NAV and the NFO price to be small; remember, early exits curtail profits.

Low-cost entry

With NFOs, investors not only can subscribe at a fixed price, they can also benefit from the lower costs of entry. This encourages new investors to invest.

Diversification

By investing in NFOs, investors can diversify their investments. New sectors like renewable energy are also opened up to investors or introduced in the market.

However, many investors believe there are better investments than NFOs, and this stems from their drawbacks, some of which are:

No track record

NFOs are for new funds. This can prove risky as there is no track record of past performances, and due diligence and technical analysis of the fund cannot be done. Once introduced in the market, they can underperform.

NAV bluff

NFOs have lower NAV because of the low price of the units (Rs 10), but that does not make the scheme necessarily profitable; it is the worth of the underlying assets (where the scheme’s investments are) which determines its profitability. New investors often miss this point.

Mutual fund NFOs are mainly divided into 3 types:

1. Open-ended NFOs

Open-ended NFOs or open-ended mutual funds are ones that do not have a fixed subscription or maturity period. Investors may purchase or sell the units of this fund at any point in time. This means that the fund issues and redeems the units based on investor demand and convenience.These funds provide liquidity, flexibility and convenience to investors. The NAV of an open-ended fund is decided at the end of the trading day based on the value of the underlying assets.

2. Close-ended NFOs

Close-ended NFOs are characterised by their fixed subscription and maturity dates. Once the subscription period ends, the fund does not accept any further investments. Closed-ended funds are better suited for investors with a defined investment horizon and who intend to retain their investments until maturity because of the fixed maturity time.Close-ended funds come with unique features and investment strategies and may offer the potential for higher returns compared to open-ended funds due to their active management and a limited number of units issued. The fund manager also has the flexibility to focus on specific market opportunities without worrying about continuous redemptions and inflows.

3. Exchange Traded NFOs

Exchange-Traded NFOs (ETF-NFOs) are a type of New Fund Offer (NFO) where the units of the mutual fund scheme are listed and traded on a stock exchange, just like individual stocks. These NFOs issue a fixed number of units during the subscription period, and once the NFO is closed, investors can buy or sell these units on the stock exchange at prevailing market prices throughout the trading hours.ETF-NFOs provide investors with an efficient and accessible way to diversify their portfolios and participate in various segments of the market while enjoying the benefits of exchange-traded instruments. Also Read: Understanding NAV for Mutual Funds

As mentioned at the outset, NFOs are like IPO in the sense that both raise funds from the public and are regulated by SEBI, but beyond that, there is not much similarity. In fact, there are several differences, as listed below:

• IPOs are issued by a company, while NFOs are issued by an AMC.
• IPOs dilute the stake of the promoters of issuing companies, NFOs don’t.
• An IPO has specific allotments for different categories of investors like NII (Non-Institutional Bidders), retail investors and QIB (Qualified Institutional Bidder). Some even give an additional discount to investors. NFOs do not offer any discount or have specific allotments of units.
• IPO pricing depends on a range of factors: the project for which money is being raised, the brand image and credibility of the issuing company, demand for the product, market conditions etc. As against this, NFOs usually come out with a price band of Rs. 10.
• An IPO’s valuation is based on EV/EBITDA ratio of the company (i.e. its enterprise value / earnings before interest, taxes, depreciation and amortization). It also depends on the PE ratio and the price-book value) ratio. The NFO cannot be evaluated since it is newly introduced.

Also Read: The ABC of IPOs in India: A Beginner's Guide

Like all forms of investment, NFOs also come with their set of risks. However, the reasons why investors choose to invest in NFOs might just outweigh the risks:

• NFOs are an opportunity to invest in a new scheme with a strategy that has a constitution in securities that isn’t already available in the market.
• It can be a cost-efficient investment for investors because of the low expense ratios of NFOs. They usually start with a small asset base as compared to established funds, allowing for the lower expense ratios.
• Since NFOs invest in new securities and strategies, they may have the potential for better performance during specific market conditions.
• Investing during the NFO period allows investors to enter the fund at its initial Net Asset Value (NAV). As the fund's performance improves, early investors can potentially benefit from higher returns.
• NFOs can offer unique investment themes or asset classes, providing an opportunity for portfolio diversification. Adding different asset classes can help spread risk and enhance overall portfolio performance.

Before subscribing to NFO, an investor needs to consider a few aspects:

Importance of the offer document

It is important to read the offer document submitted to the SEBI; it has all relevant information related to the NFO.

The objective of the Fund

The fund’s objectives give information such as liquidity, asset allocation, estimated returns etc., which can give the investor an idea of what strategy the fund manager is likely to adopt.

Total investment cost

Investor must be aware of the expenses associated with an NFO; there is a minimum amount payable for subscription, and while there is no entry load, there is an exit load if the units are redeemed before the end of the term. Investors should also have an idea of the expected returns.

Reputation of AMC

Before investing, it is advisable to check the credibility of the AMC and the fund manager, as well as their past performance. In fact, investors should look up how the fund manager has handled the NFOs in the past.

Risk factor

Another aspect to check out is the risk factor; investing in NFO is always a tricky path, given that the scheme is new and has no history of its past performance that can be analysed. This apart, the offer document also spells out the risks involved. Investors should have an idea of what lies ahead.

Tenure of the investment

The average lock-in period for debt funds is generally between three and five years. If investors cannot stay invested for this tenure, they must consider investing elsewhere. Also Read: Asset Manager or Fund Manager Which One Should You Pick?

There are two ways of investing in an NFO; these are: 1. Through a broker: This is a simple way of investing where the investor contacts an authorised broker to file the application forms and provides the supporting documents. The broker does the rest. 2. Through online trading account: One can also invest directly through a demat account. The investor chooses the NFO, clicks on the number of units purchased along with the investment period, and pays online using net banking, card or UPI. Once this is done, the details will reflect in the investor's demat account.

Investing in the NFO of a mutual fund scheme, even if risky because the scheme is untested, can be rewarding as well. It can be a good option for people with extra funds who are willing to take risks and invest long-term.But before going ahead with the investment, it is advisable for investors to consider various aspects of the NFO, such as the mutual fund scheme's objective, the projected returns etc.