As more and more investors are now eager to venture into the financial market, there has been an upsurge in investment in mutual funds through New Fund Offers (NFO). NFOs are new mutual fund schemes which offer you a chance to buy units at the initial price of Rs 10. In this article, we demystify the NFO, tell you what they are, how they work and whether is it safe to invest in NFO. We will also know if NFO can be a good option when certain conditions exist in an ideal situation. We will also give you general guidelines which can help in determining whether putting your money in NFO would be apt for helping meet your goals. You will have a complete idea of the advantages and disadvantages of investing in an NFO and what factors are to be taken care of before making your decision.

New Fund Offers (NFOs) refer to the initial offering of a mutual fund launched by an asset management company (AMC). The offer period for the NFO is generally open only for a specified time frame during which investors can invest in the fund at their respective prices. After the NFO period is over, fund launches and units purchase and redemption is done at the prevalent Net Asset Value (NAV). NFOs are akin to Initial Public Offerings (IPO) in the share market, where investors invest money for buying units of a mutual fund, unlike shares. The amount collected during the NFO is used by an AMC to buy securities as per the investment objective of a scheme.

There exist a lot of myths around NFOs and some misleading information surrounding them which can be harmful to investors. Awareness is the key! Here, we list down some of the myths associated with investing in NFOs.

Myth 1: NFOs are similar to IPOs

One of the most common misconceptions is that NFOs are like IPOs in the stock market. But there are many differences between them. A company sells its shares to the general public for the first time in an IPO, and these shares are priced based on market demand vs supply. Investors can make back a lot of money in that process if the company performs well. An NFO, on the contrary, is when a mutual fund opens for investors to buy its new scheme and units are issued at a fixed price, generally at Rs 10. An NFO does not necessarily increase in value shortly after it is launched — unlike during an IPO. The performance of NFO depends on the underlying assets or investment strategies of the fund manager. As a result, investors should not expect NFOs to give immediate gains as in the case of IPO, since the increment of mutual fund units is normally over a period depending on market conditions.

Myth 2: NFOs are cheap

Another popular myth is that NFOs are cheaper than existing mutual funds because they come at a price of Rs 10 per unit. But a price of Rs 10 is not indicative of the worth or potential of the fund. A better indicator of the mutual fund’s performance is its NAV (Net Asset Value). If for instance, it opens at Rs 10 compared to a mutual fund with a higher Net Asset Value (NAV) then the existing mutual fund might still deliver more returns. The term 'cheaper' in the context of NFOs is a misnomer; what an investor actually pays also depends on factors such as entry load, management fees, expense ratio, etc. Moreover, the underlying portfolio of the NFO may not differ much from the existing funds available and hence investing in an NFO does not ensure a better or relatively more economical option for investments.

Myth 3: New does not mean better

NFOs are mostly bought simply because they are new and there is a myth that NFOs offer innovative investment strategies or better growth just because they are new. However, a new fund is not inherently better than an existing financial device. Unlike new mutual funds, existing ones have a performance track record that investors can use to assess past returns and risk management as well as fund management decisions. NFOs, however, due to the absence of past data about their performance, evaluating how well they would perform is an impossible task. Just because an NFO is a new product it does not mean that it would perform better than all existing funds, or offer some unique functionality. Before investing in any NFO, an investor should also look for factors such as the objective of the investment fund, its strategy and AMC’s reputation.

It depends upon your investment objective, risk appetite and market patience to look at investing in NFOs. Though NFOs can provide lucrative opportunities, they come with their own set of risks like no track record and market volatility. While making a decision you should keep these points in mind and align them with your investment objectives.

Deciding on whether you should invest in an NFO or not hinges heavily on the kind of financial goals and risk appetite you have and that differs from one individual investor to another. While NFOs can be an option for investors looking to diversify their portfolios or invest in a new asset class, they are not always the best choice.

According to the estimates of financial experts, nine out of ten investors should stay away from investing in NFOs. One of the weakest parts of NFOs is the lack of a historical performance track record, coupled with chances for very high expenses and market risks making them less attractive compared to existing MFs.

No track record

The absence of a track record is one of the most important reasons to stay away from investing in an NFO. NFOs do not have a performance record like the general mutual funds, which allow investors to check past performances. Without any of this data, it's difficult to make an objective judgement on how well the fund could perform or perhaps manage risks. Investors are left taking the fund manager's word that they can execute the strategy more generally and haven't been tested with any solid evidence.

No meaningful differentiation

Most NFOs have nothing different to offer in comparison with existing mutual funds. They could invest in asset classes or sectors of the same level — effectively ending up doing nothing special for investors. When NFOs come without a clear-cut strategy or objective, they end up mimicking the performance of other available funds and do not meet any fresh requirements. It is critical for investors to meticulously examine whether the NFO offers anything unique in their portfolio that existing funds are not likely to be able to deliver.

Timing may not be right

The NFO launch may not always happen when the market is right. This is because if the NFO gets launched in a weak market climate, then it may struggle in being able to recreate its desired investment objectives at least during the short term. NFOs are often aggressively marketed during times when market sentiment is bullish, which may not be the best time for investors to invest in new mutual funds. The market and economic conditions should be observed by the investor before investing in a NFO to avoid investing latterly in short-term movements.

Although NFOs may not be viable for most of the investors, it can become a lucrative proposition under some circumstances. This usually takes the form of certain situations which present an opportunity to deliver real value in terms of returns to investors under those conditions.

Condition 1: Unique fund strategy

If a NFO provides an investment with a strategy that is not available through existing mutual funds, then it could turn out to be a good option. For example, if a NFO focuses on a new sector, a different geographical region or a specific investment that could add to the diversification of your portfolio. In case the investment objective of this fund suits your long-term requirements and introduces you to newer opportunities, it might be a good idea.

Condition 2: Experienced fund manager

The fund manager’s experience and past performance are some of the few things due to which an NFO is considered successful. If the NFO is from a well-established fund management company and is managed by an experienced fund Manager with a past track record of managing similar funds successfully, then it may be considered for an investment. A professional fund manager can help navigate through this labyrinth and make better investment decisions, improving the chances of healthy performance.

Condition 3: Fund category or strategy that benefits from lower fund size

Certain fund categories or strategies are better off with a small asset size and hence the NFOs can fit such cases. E.g. small-cap funds or those investing in liquid assets can have an advantage with the smaller size because they can be more agile and robust in their investment decisions. Having a smaller fund size also means that the manager can enter niche opportunities which may not be available to larger managers. If the NFOs belong to a similar category and fit into your strategy for investing, it could be an excellent portfolio diversification opportunity.

NFOs could be both opportunity and risk depending on the strategy of the fund, the manager’s experience and market conditions. Although NFOs do not have a historical performance track record and may end up replicating what exists, yet there are certain cases where they can provide peculiar benefits. Understanding this is very important before you invest in an NFO.

By using the tools and resources available on Bajaj Finserv Platform, you can determine if NFOs are suitable for your investment portfolio. Based on your financial goals, you can choose from a plethora of mutual fund schemes and use their resources that make investing in mutual funds easy and hassle-free. You can even compare mutual funds and know more about NFO on their platform.