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New Fund Offers (NFOs) have become a popular method for investors to enter the mutual fund market, with fund houses regularly launching these offers to attract fresh capital. However, since the mutual fund industry was re-categorized in FY18, fund houses are allowed to launch only one active fund per equity category.
Despite this limitation, fund houses have found a workaround. They can launch an unlimited number of funds in categories like 'other schemes' and sectoral/thematic funds. This flexibility has led to a significant rise in the number of sectoral, thematic, and passive funds being introduced to the market.
However, not all new funds are the same, and it's crucial to carefully assess whether these funds genuinely offer value to your investment portfolio. In this guide, we will explain how NFO investing works, clarify some common misconceptions, and help you make more informed decisions before investing.
Understanding NFO investing
It is the launch of a new mutual fund scheme by a fund house for a limited period, typically lasting between 15 to 30 days. During this period, investors can purchase units of the fund at a NAV (Net Asset Value) of usually Rs 10 per unit.
While the NAV of the new fund is set at a meagre Rs 10, it's important to remember that this doesn't mean the fund is inherently "cheap" or a good deal. The true value of a mutual fund lies in its portfolio - how it is managed, the assets it holds, and the returns it generates over time.
Suggested read: NFO trends in recent years
How is NFO investing different?
Through NFO investing, people expect to get the same kind of listing gains that they do from an IPO (Initial Public Offering). But there are significant differences between the two.
Does demand affect the NAV of an NFO?
One of the most common misconceptions about NFO investing is that the demand for units during the subscription period can drive up the NAV, much like in an IPO, where high demand for shares often pushes the stock price higher. However, this is not the case with New Fund Offers.
For an IPO, the stock price is determined by market forces - supply and demand - leading to fluctuations in its value. In contrast, new funds have a fixed NAV of around Rs 10 per unit during the subscription period. The key here is that there is no cap on the number of units that can be created for the mutual fund. Each time an investor buys a unit, the mutual fund simply creates new units, which leaves the NAV unaffected. However, the NAV will grow if the fund's portfolio does well.
Suggested read: Low NAV doesn't mean cheaper fund
What should you ask yourself before investing in an NFO?
Before jumping into NFO investing, ask yourself a few critical questions to ensure that you are making an informed decision. These questions will help you assess whether the fund aligns with your investment goals and long-term strategy.
1. Does the fund add something new to your portfolio?
New funds often promise to bring something new to the table, such as exposure to a particular sector, theme, or market. However, it's crucial to evaluate if this "newness" truly benefits your portfolio. Ask yourself:
- Do you already have exposure to this sector or theme through other funds?
- Does this fund provide the diversification you need?
- Is the fund aligned with your long-term investment strategy?
2. Does the fund fit your investment needs?
Not all funds are suitable for all investors. Some may cater to aggressive investors, while others may be designed for conservative investors. Consider these factors:
- Your risk tolerance
- Your time horizon - are you investing for the short-term or the long-term?
- Does the fund complement your existing portfolio?
3. Are there existing mutual funds that follow the same strategy?
A common mistake investors make is assuming that new funds are automatically better investments because they are "new". However, established mutual funds with a proven track record may offer similar investment strategies with lower risks. So, it is essential to assess whether you are adding a fresh fund due to just its novelty or if the fund offers something unique to your portfolio.
Suggested read: Ask these three questions before investing in an NFO
What are the common misconceptions about NFOs?
NFO investing is often misunderstood due to the hype built around it. Let's address the misconceptions of this popular investment route:
1. NFOs have a low entry barrier
Many investors assume that the fixed price of Rs 10 means that it is easier to get started with a new fund. However, you can buy a fraction of a mutual fund, irrespective of the mutual fund's NAV. The only entry barrier is the minimum investment amount, which is low in the case of most existing funds. So, a low NAV or high NAV has no bearing on the ease of entry. Instead, it is the minimum investment amount stipulated by the fund house.
2. The funds have a low expense ratio
Some investors believe that a brand-new fund will have a lower expense ratio, making it more cost-effective. However, SEBI regulations state that funds with low AUM can charge higher expense ratios. Which means that these funds usually have higher expense ratios as their AUMs remain small for quite some time.
3. These funds offer diversified portfolios
It's common to assume that a new fund will complement your portfolio. However, the hordes of new sectoral and thematic funds focus on a specific segment of the market. Any plain vanilla diversified equity fund can offer you exposure to not just that sector or theme but also help you benefit from a host of other opportunities in the market.
Should you invest in an NFO?
Whether or not you should invest in an NFO depends on several factors, including your investment goals, risk tolerance, and the specific value proposition of the fund. If the NFO aligns with your investment strategy and offers exposure to a market segment that is currently missing from your portfolio, it could be worth considering. But it's important not to be swayed by the novelty or hype surrounding the fund.
However, it's often wiser to invest in mutual funds with a solid performance history, particularly those that have weathered at least one full market cycle of five to seven years. Established funds tend to carry less risk and offer more predictable returns. For most investors, diversified equity funds with a proven track record should suffice as they offer broad market exposure and reliable performance.
If you want to invest in an NFO, make sure you consider the factors we've outlined to ensure you're taking an informed call. It's essential to evaluate whether the NFO truly adds value to your portfolio and offers something unique that other existing funds may not.
To get detailed assessments of upcoming fund launches, check our NFO review section. It will give you a bird's eye view of all the new funds that are on the way.
Also read: Why you should avoid NFOs
This article was originally published on December 06, 2024.
Disclaimer: This content is for information only and should not be considered investment advice or a recommendation.
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