Last Updated on Aug 26, 2021 by Aradhana Gotur
Recently, India has witnessed enormous growth in the investment side of the financial markets. In the last 10 yrs, the Asset Under Management (AUM) that determines the size of the mutual fund industry has grown from Rs 7.30 tn to Rs 33 tn. The AUM grew more than 2x (times) in the last five years.
The data shows the involvement of retail investors in the financial markets, especially mutual funds. It has expanded exponentially. To leverage this new interest among investors and to cater to their every investment need through innovative concept investing, mutual fund houses are coming up with various new NFOs. NFO full form is New Fund Offer.
This article covers:
- What is NFO in mutual funds
- Why do asset management companies Issue NFO
- Why do investors subscribe to NFO
- Types of NFO in mutual funds
- Features of NFO in mutual fund
- How does an NFO work
- How to make money by investing in NFO
- Limitations and risk of NFO in mutual fund
Table of Contents
What is NFO in mutual funds?
NFO meaning is a new fund offer, the process through which new schemes are introduced in the market by mutual fund houses. The working of an NFO is similar to that of launching an Initial Public Offering (IPO). In the IPO, the company raises capital via launching equity shares to the public for the first time. NFO means, the mutual fund house raises capital by making the fund units open to the public at a certain rate, at a cheaper rate, and for a specific period.
Now that you know what is NFO, in India, generally, the rate is Rs 10 per unit. Once the NFO period ends, investors purchase the unit at a higher price than was issued during the NFO period – the market price. Usually, NFOs are launched as per a theme by the mutual fund house.
Why do asset management companies issue NFO?
NFO is offered to the investors when an Asset Management Company (AMC) decides to launch a new mutual fund scheme in the market. While launching an NFO, the fund house publishes all the documents related to asset allocation, investment strategy, information of the fund manager, and all the other information to gain investor’s trust.
What is NFO is, it is a means for raising capital for the fund. The raised capital is used to maintain the cash reserve for the investor’s exit. If a mutual subscriber/investor plans to take an exit, the AMC has to pay the investor from cash reserves. In the past year, around 87 NFOs were launched by various Asset Management Companies.
Why do investors subscribe to NFO?
Once investors know what is NFO, they may find investing in an NFO is cheaper than subscribing to an existing fund whose price becomes market-determined. Therefore, investors have higher chances of earning more money by investing in an NFO than subscribing to an existing fund. The return on investment provided by an NFO mutual fund is generally higher.
NFO might seem a safer option to invest in when compared to other initial offerings such as IPO. However, there are risks associated with every form of investment in the market. Therefore, you should research thoroughly before making any investment.
Types of NFO in mutual funds
In India, mutual funds are segregated based on their investment structure. They are categorized into two types: open-ended and closed-ended mutual funds.
Open-ended mutual funds
Open-ended mutual fund schemes provide an open redemption option to their investors. The investors can sell their units in the market whenever they want to. There is no limitation on entry and exit for the investor.
These are the most widely accepted forms of mutual funds in the Indian market. The asset management companies provide open-ended funds because there is no limitation on the amount of capital these funds can raise. These funds do not have a limit on assets under management, that is, open-ended funds can raise unlimited amounts from investors.
Closed-ended mutual funds
Unlike open-ended funds, these funds have limitations on entry and exit. Generally, investors can subscribe only during the NFO period, and the exit depends upon the maturity of the fund. Mostly, the maturity period is between three to five years.
However, this is not always the case. Sometimes, the asset management companies might transform the closed-ended funds into open-ended funds, by selling the assets to open-ended funds. To convert closed-ended funds into open-ended funds, asset management companies require the consent of the investors.
Features of NFO in mutual fund
Here are some of the most commonly known features of NFO:
Since NFOs are to raise fresh capital, the asset management companies come up with new strategies. Investors get an opportunity to invest in these innovative strategies that suit their risk appetite and diversification goals at a cheaper rate. For instance, some of the funds invest in pre-IPO companies. Some invest in companies that prioritize green energy and so on.
The liquidity feature majorly depends upon the investment structure of the fund. If the fund is an open-ended fund the liquidity would be high. Closed-ended funds have lower liquidity in the market.
It is important to do thorough research before investing in any financial product, after all, it is your hard-earned money. Therefore, to get an idea of the return, check the fund manager’s past performance data. Also, check funds of the same category, and it is advised to invest only if you are convinced that the fund has the potential to beat returns from the index.
Minimum investment amount
The investment requirement for NFO generally ranges between Rs 500 to Rs 5,000. It depends upon a lot of factors, majorly the fund house. These criteria can help you cut down your investment options, and you can choose the best option as per your budget.
How does an NFO work?
The investment horizon for NFO is short. That is, NFOs are open for investment only for a specific period. This time is decided by the fund houses, based upon the industry average.
Moreover, the price of an NFO is generally fixed at around Rs 10. The investors take advantage of buying units at a cheaper rate, and after listing, they stand to gain hefty returns.
How to make money by investing in NFO?
The basic rule to make money via trading is by buying cheap and selling expensive. Any form of trading, including stock or even physical commodities, you earn money by purchasing it at a cheaper rate and then selling at a higher rate.
Similarly, in the case of NFO, you get a chance to buy units at a cheaper rate. If you invest in an open-ended fund, then you can sell once the price rises over time. Most products in the financial markets provide good returns, if stayed invested, for a longer duration.
Limitations and risk of NFO in mutual fund
Here are some reasons why investing in NFOs is risky:
Being a new mutual fund scheme, there is only limited data that is available to the investors. Therefore, you can not trust every NFO to provide a good amount of returns. Also, it’s not always right to invest only based on new investing strategies. With new ideas, there come a lot of difficulties, thus, you need to do thorough research before making any investment.
Returns from NFOs are not like IPOs
Mutual funds are traded differently than stock. A company’s stock has a limited number of shares trading in the market, therefore, the stock prices rise when the demand increases. On the other hand, mutual funds can take as many entries as they want. The NAV of a fund does not depend upon demand and supply, but rather on market returns. Therefore, prospective NFO returns vary from expected IPO returns.
There’s a fee that is charged by fund houses to manage your money called the expense ratio. It is expressed as a percentage of the AUM of the fund. Entry and exit loads are also applicable in some funds.
A New Fund Offer (NFO) is a mutual fund scheme’s debut at the market. Units of a mutual fund are made available to the public for purchase for the first time through an NFO. It is one of the ways by which fund managers deploy new techniques and bring innovative products to the market.
Investing in NFO has its benefits as well. A well-researched investment in an NFO can create wealth for an investor in the long run. Therefore, read all the documents related to the fund, track the past performance of the fund manager and comb through the investment scheme document before investing in an NFO.