NFO Meaning: Should you invest in an NFO?

Contents

Definition

NFO Meaning– NFO stands for New Fund Offer. When an Asset Management Company (AMC) decides to launch a new mutual fund in the market, the route that it takes is called an NFO. Through the NFO, any investors get an opportunity to invest for the first time in a new fund.

If an investor has not invested in an NFO during the NFO period, the same scheme will be available to buy in the market after the period is over. But for that, you will not get those units at face value. You can purchase those units at the price that is going on in the market called Net Asset Value or NAV. 

Types of NFOs

NFOs can be open-ended or close-ended. In an open-ended NFO, an investor can invest and come out at any point in time, and there is no lock-in period. But close-ended NFOs are for a stipulated period of time. It could be for 1-year, 3-years or even more.

Process of NFO Meaning

Any mutual fund scheme is offered to the investor through a legal document called an offer document. An Asset Management Company launches a new mutual fund scheme or NFO through the Chief Marketing Officer (CMO) and the Chief Investment Officer (CIO) research and information.

After the CMO and CIO’s information, the AMC prepared a draft document, which is then sent to the Trustees and Board of Directors for approval. And only after their approval a new scheme can be launched in the market.

The trustee has to give an undertaking that this scheme is completely new and it is not launched in the name of a new scheme by making changes in an old scheme. After that, this offer document is sent to the SEBI for approval. If there are any SEBI observations, it has to tell the AMC within 21 days. And if there are no observations from SEBI within 21 days, the AMC understands that SEBI has given approval, and this scheme can be launched in the market by the AMC.

Later by looking at the market’s condition, the AMC created a time table for its issue and launched it according to the time table.

Features of NFO Meaning

  • Usually, the NFO is for a maximum period of 15 days, during which investors can buy units for the first time from a mutual fund company at Rs 10, also known as the face value (FV) of units. 
  • As per SEBI regulations, an NFO cannot be for more than 15 days of duration except ELSS schemes for 30 days. Once the NFO period is over, most funds are converted into open-ended funds, which means these funds can now accept fresh money or new investments into the fund.
  • After the NFO is closed, the AMC has to allot the units to the investors within five days. Otherwise, it has to refund the money back. If it is unable to allot the units and delay giving the refund, it has to pay interest @ 15% per annum for that period.
  • In an open-ended scheme, the scheme should be available in the market to buy and sell again within five days after the NFO is closed.
  • Whenever you invest in an NFO, the only source of information, i.e., what does the scheme stand for, where will the money be invested, who will manage the fund, etc. All those details will be available in a document known as an offer document or Scheme Information Document (SID).

NFO Meaning

NFO vs IPO Meaning

NFO and IPO are not similar, but two different processes. In an NFO, AMC will offer units for the first time to investors. Investors can buy units at their face value which is Rs 10.

In case of an IPO, the company is going public for the first time before it gets listed on the stock exchange for everyday trade. You buy a stock cheap and sell it high to make profits. So, the entire buying decisions are based upon the growth prospectus of the stock.

Through IPO, the company’s promoters offload a limited number of shares for purchase by the public. That means the number of shares offered in an IPO is restricted. An IPO is merely a limited transfer of ownership from the promoters to retail investors.

But in the case of an NFO, you are initially giving money to the mutual fund company to create a portfolio. The fund manager, based upon the investment objective of the fund, creates an initial portfolio. And the portfolio is a collection of stocks that is never constant. It keeps changing based upon the market conditions and the fund manager perception of the market. The new fund’s performance is entirely based upon the fund manager’s ability to run the fund.

Unlike a company where the shares are limited, the units offered in an open-ended mutual fund keep increasing as more fresh money investments keep on rolling in.

Disadvantages of NFO Meaning

  • NFO does not have a past performance track record to look at. So, you would not know how the fund could perform when the market moves up or moves down. However, in the case of already existing funds, you have a track record to look at, and then you can choose whether you can invest in that particular fund or not.
  • The fund manager’s investing style, i.e., how much amount will he invest in large-cap, mid-cap, small-cap or any other securities, is not clear.
  • New funds have low AUM, which attracts a high expense ratio as compared to well-established funds. And a high expense ratio lowers the amount of profit.
  • In an NFO, you have to trust the fund manager, but if the fund manager is new, you don’t have his/her capability.

Are NFOs costlier to investors?

Every scheme charge management fees. This charge helps AMCs manage your money better by recruiting fund managers, buying and selling securities and dozens of other procedural works. These fees are known as expense ratio and are generally charged as a percentage of the AUM.

Now, India’s mutual fund regulations allow a fund with a smaller AUM to charge a higher expense ratio compared to a fund with a larger AUM. The expense structure keeps reducing as the fund size increases. Generally, most NFOs charge around 2% as an expense ratio. However, established funds with larger AUM have a much lower expense ratio, which means the NFO fund can charge you a higher expense ratio than established funds.

NFOs are not a bargain at Rs 10

The money you make from a mutual fund depends on the relative growth in the Net Asset Value (NAV) and not the absolute price of the NAV. E.g., it is very much possible that the fund you bought at a NAV of Rs 10 might grow by 10% and reach a NAV of Rs 11. And a fund with a NAV of Rs 200 might jump 20% to Rs 240. So, a 20% growth in NAV is far more profitable than a 10% growth in NAV. It clearly shows that fund performance is relative to the NAV at which you bought and is not relative to the absolute value of the NAV.

Things to consider while investing in an NFO Meaning

Most people invest in funds after looking at the track record of funds. We generally find investing in a fund after seeing the 1-year performance, 3-years performance, rating, ranking, comparison with other funds, fund portfolio etc. The fund to be launched in an NFO is entirely new with no performance history, no portfolio of assets, no ranking, no rating, absolutely no experience.

In 2018, SEBI, i.e., the Securities and Exchange Board of India, made it compulsory for AMC to launch only one fund per category. Before 2018, some mutual fund companies have 3 large-cap funds, 4 multi-cap funds, and so on, which is a great job of confusing investors. But now all that is over.

One mutual fund company can have only one scheme per category. So, one large-cap, one midcap, one multi-cap fund and so on, which means that if a mutual fund is to launch an NFO, it says that they have no experience in that category. The category itself is new for the fund house, and the fund manager will take some time to develop his/ her investing strategies.

Suppose a fund launched in a category where several funds already exist, then picking a fund with an existing track record is always better. E.g., the midcap category has 20 schemes for you to choose from. Of these 20 schemes, 15 schemes have been in existence for over 10 years. That is a lot of experience, historical information that you can use to decide which fund to invest in rather than going in for a new fund offer.

 

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