Before You Invest: NFO

25 January 2023
5 mins read
Before You Invest: NFO

An Asset Management Company (AMC) is an excellent option if you are looking for someone to manage your investments. An AMC invests funds gathered from clients through pooled structures such as mutual funds, index funds, and ETFs, which are managed in a single centralized portfolio. AMCs manage your money and hence, are rightly referred to as money managers or money management firms.

One such pooled structure is a New Fund Offer (NFO). An AMC can raise capital for a new mutual fund in the market through an NFO that closely resembles the concept of an IPO. An NFO of a mutual fund outlines details of the portfolio such as:

  1. Names of the publicly listed shares that will be purchased
  2. Kind of securities that will form the portfolio
  3. Fund Manager/s

Why opt for an NFO? When an NFO of a mutual fund is launched for a limited period (max. 30 days as per SEBI guidelines), you can invest more by purchasing units of a mutual fund at subscription price instead of their Net Asset Value (NAV). The subscription price is usually set at Rs. 10 per unit. After a limited period, such mutual funds may be traded in the market based on their respective NAVs. Because the units are purchased at a nominal cost, you can realize substantial profits later, thereby enhancing your capital gains once the mutual fund is available for trading in the open market.

In order to understand the meaning of an NFO, it is crucial to understand the two types of New Fund Offer:

1. Close-ended funds

Rather than using jargon, let’s simplify through an example:

Suppose you subscribe to the close-ended NFO of Z mutual fund for 1000 units at Rs. 10 each. After the limited period, let’s say that the mutual fund has a NAV of Rs. 12 in the stock market owing to the fluctuation of the prices of the assets in the mutual fund portfolio. Thus, the value of your 1000 units will now be 20% higher at Rs. 12000 (1000 x 12). If you decide to sell your investment in the stock market and investors are willing to offer you Rs. 15 per unit, then your mutual fund is trading at a premium of 25% to its NAV price. Conversely, a mutual fund could even be trading at a discount to its NAV price that could be lesser than even the subscription price, and selling such units would incur a loss.

In close-ended funds, the corpus is fixed, and no further addition is allowed to the mutual fund portfolio after the subscription period is over. Purchase or sale of the units of such a fund can only be done through market exchange, similar to stock market trading. Prices of the units will be determined based on their demand and supply in the market.

Close-ended funds are usually passively managed by portfolio managers and replicate the returns of a benchmark index. You can invest in a close-ended fund only through NFO.

Never underestimate the power of compounding. What matters is spending time in the market. Backing out within a short period can end up impairing your returns. This is where close-ended funds come to the rescue with their lock-in period of 3-4 years.

Moreover, the fund manager of a close-ended fund can hold a part of your funds to invest them later when the timing is right, thereby offering greater flexibility.

2. Open-ended funds

Do you want to buy more units of the mutual fund even after the limited period of the NFO? Go for an open-ended fund that will allow you to purchase additional units at the respective NAV. Most mutual funds are open-ended funds and are usually actively managed by portfolio managers.

Now you must be wondering how to go about investing in an NFO? You can do it either through a broker or through your online trading account. Brokers not only help you with applications but also provide doorstep services and info regarding the future performance of the mutual fund. Make sure that you seek the services of an authorized broker. If you already have an online trading account through which you invest in shares and mutual funds, you can use it to invest in NFOs too. Moreover, your online trading account can be used to track the NAV of the mutual fund.

Tips before you zero down a New Fund Offer:

  1. Ensure that the AMC launching the NFO has a good reputation and has good fund managers, especially if the fund will be actively managed.
  2. A minimum number of units have to be purchased while subscribing to the NFO of a mutual fund. Ensure that you are willing to take up the investment burden to partake in the scheme.
  3. Go through the list of securities that will be obtained through the capital from the NFO. The risk associated with different types of securities is different as also is the expected return on investment. If you are risk-averse, avoid equity mutual funds, small-cap and mid-cap companies, and go for NFOs that will primarily invest in debt funds or blue-chip companies. Conversely, consider NFOs that will invest aggressively in equity through trained portfolio managers if you love risk.

If you have done your homework well and know the benefits that you can avail of from an NFO, then you can multiply your wealth through promising investment schemes. Investors should have comprehensive knowledge regarding a New Fund Offer and its activation date before investing in them. Hence, read the product-related terms and conditions carefully.