- Date : 07/04/2021
- Read: 5 mins
NFOs can be a secure investment for investors. Read on to know why.
A New Fund Offering (NFO) is an investment opportunity that offers units of existing high performing mutual funds to the public. It is launched by Asset Management Companies, thereby increasing the Asset Under Management (AUM). Fixed-income investors tend to prefer NFOs as they provide a steady income, either monthly or quarterly.
What is the purpose of an NFO?
Fund managers create this opportunity of investment to help maximise additional sources of funds and optimise the fund basket for all stakeholders. They invest these funds mainly in buying securities like equity shares, government bonds etc. Through strategies like open-ended funds and closed-ended funds, they provide returns to the investors.
What are the different types of NFOs?
- Closed-ended funds: These need to be procured during the launch of the NFO and have a lock-in period of 3-4 years. Secure put options stabilise the downside of these funds. In theory these funds are traded in the stock market, but in reality they have low liquidity.
- Open-ended funds: These are bought and sold freely in the stock market and there are no restrictions in terms of time or price. They are bought and sold at NAV (Net Asset Value).
What are the advantages of investing in NFOs?
- New strategies: Closed-ended funds (NFOs) come with innovative ideas for investment, which have not yet been introduced in the market. One needs to read the theme of the fund to assess its investment potential. If the strategy is new, it could be a successful investment, but an idea that exists in the market and is reintroduced as something new may not offer the same bandwidth. In that case it is better to invest in stocks.
- Flexibility: Since the lock-in period is specified in an NFO, it offers both the buyer and the fund manager investment flexibility. In other words, if the investment timing is volatile and the market is at its peak, the fund manager can hold on to some of the funds and invest it later for the investor. This helps the fund manager to perform better.
- No large cash outflow: NFOs are free of large outflows of cash due to the lock-in period. As a result, the fund manager can focus on select investments in stocks and at the same time monitor investments in other stocks. This provides the security a closed-ended fund needs.
- Lock-in support: This provides the anchor an NFO needs. Bad investments are avoided as the funds outflow is checked for 3-4 years. This protects the investor from being affected by the panics and manias of the equity share market.
Related: How IPOs differ from NFOs?
What should one keep in mind before investing in NFOs?
- NFOs have mainly attracted stable income groups, especially those in the latter part of their careers who prefer to seek a steady income flow. Here the income is between 3-4%, where the loss of investment is safeguarded by put options.
- Research: A thorough research of the mutual fund needs to be done. NFOs issued by performing mutual funds are generally expected to perform substantially well. The fund house needs to show a good performance for the past 5-10 years to secure good returns.
- Clarification of objectives: A thorough reading of the objectives of the NFO is required. The NFO investor needs to be able to understand how the investment is going to be used. If this is not clear to the investor, it means there’s a flaw in the investment process. This step is required to gauge the viability of the NFO.
- Theme analysis: The theme of the NFO needs to be ascertained next. If the theme is unique and not a copycat of an existing fund, you are likely to bag the correct NFO for investment.
- NFO returns: A verification of the past returns could be done if the fund has been operating for some years. If money has already been invested in the fund, a quarterly analysis can be done for the first 2-3 years to monitor the returns. Simultaneously, a check should be done on the trends against peer funds and the index, to gauge the performance and derive an expected return.
- Closed-ended risks: NFOs could be risky as innovative ideas might or might not succeed. Moreover, the investor is not privy to how the fund manager will utilise the investment. A performance check of the fund manager can be done, but it is still difficult to derive how a brand new fund would perform in the market.
- Checking cost in investment: It is important to check whether the cost ratio is as mandated by SEBI or lower. A charge for exiting the plan before the tenure needs to be factored in, along with the annual fee charged by the fund house. These expenses need to be deducted from the projected income.
- Subscription fee: This is another criterion to assess the decision for investment. If the subscription is higher than the available fund, the investment needs to be re-evaluated. It might be better to put your money into a Systematic Investment Plan (SIP) in an existing high-performing fund.
- Investment duration: All NFOs come with a lock-in period of 3-5 years. So, it is advisable to be completely sure of your decision as high fees could be charged for an early exit. Patience is required to stay invested for the long term.
Related: Understanding NFOs: 5 Things you must know about this investment instrument
It is not advisable to invest your entire available fund in NFOs; you should spread it among various investment options. The decision to invest in an NFO should be made after a thorough study of the risks involving the mutual fund, the fund manager, and the objectives of the fund. If you are unwilling or unable to do the research, it may be better to buy at the Net Asset Value (NAV), after the offer period is over.