5 Things Investors Should Consider Before Investing in Upcoming NFOs in 2022

July 7, 2022 Mutual Fund

The past year 2021, witnessed a spate of New Fund Offers (NFOs) launched by mutual fund houses to raise capital, riding on the back of a sharp market rally and rising interest from retail investors and asset management companies (AMCs).

However, the Securities and Exchange Board of India (SEBI) circular dated March 31, 2022, extended the deadline for discontinued intermediate pooling of funds and/or units in Mutual Fund transactions by stock brokers/clearing members on Stock Exchange platforms and by other entities including online platforms, respectively until July 01, 2022.

Given that, there was discontinuation in the launch of NFOs until the new systems concerning pooling of accounts were determined, and the regulator had set July 01, 2022, as the deadline for the implementation of the new system. Several asset management companies (AMCs) are preparing to introduce new mutual fund schemes now that SEBI’s three-month ban on the introduction of new fund offerings has ended after a temporary pause.

In order to launch new schemes, AMCs like PGIM India Mutual Fund (MF), Sundaram MF, Baroda BNP Paribas MF, LIC MF, and Franklin India MF have submitted offer documents to SEBI. Going forward, various AMCs will start launching new fund offerings (NFOs) as new processes are in place and they see value in the market due to the recent correction. NFOs lead to good participation from retail investors and also increased activity from distributors.

However, many investors invest in NFOs after being persuaded, even though they are unaware of the functioning of NFOs. But is it actually a good idea to invest in NFOs? Before you invest in NFOs, let’s first understand how NFOs work?

During a New Fund Offer, investors have the opportunity to purchase units of the scheme at their face value, which is Rs 10 per unit. However, this offer is available only for a limited time period, say fifteen days or a month. After this time has passed, interested investors will only be able to purchase a security at the current NAV. Since NFOs are restricted to a confined time frame, units are allotted to investors in the order of their application. NFO subscribers, in general, have been able to generate noticeably better gains post-listing.

Investing in NFOs allows you to get exposure to a new asset class at a relatively cost-effective price point. However, does that translate into investing in all of them? Definitely not. A detailed analysis of the new fund’s objective is necessary to determine whether your portfolio needs a new theme or sector. You need to be mindful of certain aspects before investing in an NFO to ensure it doesn’t become a cause for concern.

Here are some important factors investors should consider while investing in New Fund Offers:

1. Thoroughly analyse the new fund objective

Don’t rush to pour your money into an NFO just because the units are available at a low price. NFOs look attractive at a face value of Rs 10 per unit. However, that should not be the only factor to consider in investing in NFOs. A low face value doesn’t necessarily guarantee a strong initial or sustained performance vis-a-vis other funds. You must thoroughly analyse the scheme before rushing your investment. It’s the growth rate of the NAV that matters rather than its value.

Keep in mind that the face value or NAV is only a starting point. Instead, check if the NFO is offering a unique theme or investment objective that suits your financial goals and risk appetite. The new fund offers are launched along with scheme-related information in the documents such as Scheme Information Document (SID), product presentation, etc. The desired objectives of the fund, the asset allocation, investment strategy, benchmark index, level of risk, liquidity, fund management team and other pertinent information are all highlighted in these documents. To form an opinion about the viability of the NFO, you must carefully examine all the documents relating to the scheme. Beware that for a Mutual Fund to be a worthwhile addition to your portfolio; your investment objectives must coincide with its goals.

2. Consider the expenses

An NFO associated costs must be carefully considered because they can consume a sizeable part of returns. One of several factors determining your potential returns is the overall cost of the investment. Despite the fact that there is no entry load, certain NFOs impose exit loads if you decide to redeem your units before the tenure is completed.

Another important factor is the expense ratio, which is the annual fee imposed by the fund house to manage your money. It is advised to check if the expense ratio is lower or equal to as per the SEBI mandates. The overall cost involved in investment is one of the factors that weigh on your potential returns. Make sure there is a clear explanation if you discover negative differences between the scheme’s expected expenses and the actual expenses of NFOs with a comparable history. Ensure to invest in NFOs with a lower expense ratio.

3. Background check of the fund house

It is equally essential to analyse the history of the AMC launching the NFO. If the NFO is a new kid on the block, but the fund house has come a long way. You must check the fund house’s name and stand in the industry, its adherence to corporate governance standards, etc. When compared to established fund companies that have weathered numerous market cycles, new entrants to the mutual fund industry typically have less experience.

You must analyse the performance of the fund house and that of the fund managers. Check the kind of funds they are managing and their returns generated. If it has a proven track record, then there is a possibility that the NFO will be managed prudently and may perform well. Schemes where the fund manager has changed frequently, or an NFO that is launched to revamp an old scheme must be eyed with caution.

4. Structure of the NFO

The NFO can either be open-ended or closed-ended. A closed-ended fund offers subscriptions only during the NFO period. On the other hand, an open-ended fund offers subscriptions on an ongoing basis. Most closed-ended fund units (with few exceptions) are mandatorily required to be listed on the exchanges akin to shares after the NFO ends, while for an open-ended fund, this is optional.

In addition, the new fund offer also imposes a specific investment restriction with a minimum subscription amount constraint. The SID and the application form both make clear references to the minimum investment amount. It could range from Rs 500 to 5,000. If the minimum subscription amount is higher than you had anticipated, you may consider opting for the Systematic Investment Plan (SIP) if it is available in the particular NFO.

5. The theme of the NFO

The Indian mutual fund industry is flooded with mutual fund schemes. Therefore, when you come across an NFO, it is advisable to study the fine print attentively to comprehend the fund themes. Each NFO has a distinct theme or investment objective, such as capital protection, value investing, or growth. Some NFOs choose to invest in a certain group of companies based on a sectoral theme, such as consumer, infrastructure, etc. Additionally, there are international funds. Ensure to check if the investment theme ties in with your financial needs and goals.

Generally, NFOs that are sector-specific offer limited scope for diversification. So, if one sector does not perform as expected, the returns are not compensated by another sector. The investment theme must be sustainable and something not provided by the existing schemes. However, if you discover that the new fund offer is merely a repetition of a current strategy like there is ‘Old wine in a New bottle’, then it is probably not a viable option. This will only add more funds without adding any diversification to the portfolio, and the majority of the schemes will overlap with already-existing ones.

New Fund Offers may appear to be a lucrative investment option, but before investing, it is important to consider important factors, including the fund manager, investment goals, and scheme portfolio. Ensure your risk tolerance before investing in any NFO. This is the most crucial factor. Make sure the risk profile of the fund aligns with your level of risk tolerance and investment goals.

When your risk tolerance is moderate to low, you shouldn’t invest in any NFO that suggests high risk. Therefore, it is essential to consider all relevant factors before investing in NFOs. Additionally, check if your portfolio is capable of surviving the market volatility as well.

To conclude…

New Fund Offers are opportunities to look at your investment portfolio and ask whether you need a new theme in your portfolio. From an investment perspective, it makes sense to invest in NFOs offering a unique strategy that is presently unavailable in the industry and has the potential to deliver returns in accordance with your risk profile and investment horizon. The unique investment strategy helps in diversifying your portfolio across asset classes, sectors, and market caps, as well as offers a favourable risk-reward ratio.

Therefore, you may consider investing in any New Fund Offers only if it adds value to your portfolio. Alternatively, you may stick to investing in existing mutual fund schemes that have a proven performance track record with consistent returns.

This article first appeared on PersonalFN here