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All You Need to Know About NFOs

Jul 29, 2022

All You Need to Know about NFOs

Any new consumer product, if backed by intelligent marketing, has the potential to immediately grab marketshare.

If it's attractively priced, people queue up to buy it. They perceive it to be 'value for money'.

The same is true with mutual fund New Fund offers (NFOs). Investors are often lured by the Rs 10 proposition. They think the offer is cheap. They seldom assess if it's the best fit for their risk profile, investment objective, and time horizon.

Also, most mutual fund houses are in a race to garner more Assets Under Management (AUM). They launch new schemes during upbeat market conditions and perhaps near market tops.

It's comparatively easy to loosen investors' purses when sentiment is positive.

Bull markets also help fund houses show a convincing track record of their schemes and highlight the potential profits from the NFO.

For instance, just before the markets entered a rough patch 6-7 months ago, there was competition among Indian mutual fund houses to launch overseas funds.

The US-focused funds were the most sought-after products. With new-age tech companies clocking good returns, mutual fund houses could perfectly encash the FOMO (Fear of Missing Out).

Everybody wanted to have a piece of the hi-tech stocks pie listed on American bourses. But soon, these investors faced a rude shock. The new-age stocks crashed by over 20% as the US stock markets corrected.

Then came a narrative of active versus passive. Reports suggested that active funds underperformed passive funds i.e. equity ETFs and index funds.

They are suitable for newbies who would like to make returns at low cost, in line with markets, and without being subject to any additional risk of an active style of fund management.

In fact, some passive funds NFOs are open for subscription as we write this.

ICICI Prudential Nifty 200 Momentum 30 ETF, ICICI Prudential Nifty 200 Momentum 30 Index Fund, DSP Nifty Midcap 150 Quality 50 Index Fund, HDFC NIFTY 100 ETF, HDFC NIFTY NEXT 50 ETF, and Quantum Nifty 50 ETF Fund of Fund.

A few fund houses are playing it safe and focusing on passive funds. However, that doesn't mean the active fund category is far behind in the race for AUM maximisation.

In the active fund category, Mirae Asset Balanced Advantage Fund, Quant Large Cap Fund, and Baroda BNP Paribas Flexi Cap Fund are open for subscription. WhiteOak Mutual Fund recently concluded its first NFO, the WhiteOak Capital Flexi Cap Fund.

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Don't buy into the narrative that suits fund houses. Assess if the NFO will really be worth your hard-earned money.

Here are some important aspects you should consider before investing in NFOs.

  1. Background check of the fund house

    Analyse the history of the AMC launching the NFO. If it is a new kid on the block with no experience and track record in fund management, consider giving its NFO a miss.

    Ideally, a found house should have at least 5+ years of operating experience in the mutual fund industry.

    Check the investment philosophy followed by the fund house. Check its investment processes and systems, the asset class forte of the fund house, the style of investing it follows, the background of the founders, credentials of the fund managers, the corporate governance standards, etc.

    The established fund houses that have weathered numerous market cycles would be typically better than the new entrants in the mutual fund industry. That said, avoid making investment decisions on just brand value and size.

    Assess the performance of the fund house i.e. if the proportion of AUM is actually performing. This shall help you recognise whether it is efficient in fund management or just an asset gatherer.

    Overall, if the fund house has a proven track record, then there is a possibility its NFO may also be managed prudently and perform well.

    But if the fund manager has changed frequently or an NFO is launched to revamp an old scheme, then it must be eyed with caution.
  2. 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.

    Most closed-ended fund units (with few exceptions) are mandatorily required to be listed on the exchanges akin to shares after the NFO ends. On the other hand, an open-ended fund offers subscriptions on an ongoing basis.

    It would be sensible to avoid close-ended funds altogether, as you may not be able to exit the scheme in the case of underperformance until the window for redemption opens. Plus, on the exchange, liquidity may be restrained.
  3. The investment objective and asset allocation

    As per the regulatory guidelines, it is mandatory for the scheme to state its investment objective at the outset. It is mentioned in the Scheme Information Document (SID), product presentation, etc. Read them carefully.

    Although there is no guarantee the stated investment objective will be achieved, it will help you discern whether the investment objective of the scheme is in congruence with your personal investment objective.

    Don't rush to pour your money into an NFO just because the units are available at a low price or because a star fund manager will be managing it.

    The NFO must be unique in terms of investment style, strategy, and/or theme. It must also suit your risk profile and your financial goals.

    For this purpose, understand the asset allocation, investment strategy, and the index against which the fund shall benchmark its performance. This shall help you assess the level of risk you would be exposed to rather than simply looking at the risk-o-meter, which could be misleading.

    The NFOs under consideration must match your personal asset allocation (equity, debt, and gold) and risk profile. It should offer a favourable risk-reward opportunity.
  4. The investment strategy and theme of the NFO

    Every mutual fund scheme on offer follows a distinct investment strategy and theme. This vital information is mentioned in the SID. It sheds light on the investment mandate of the fund and how the portfolio will be constructed.

    Some NFOs choose to invest in a certain type of companies based on a sector or theme - consumer, infrastructure, tech, banking & financial services, energy opportunities, ESG, etc. Plus, there are international funds too.

    Generally, such sector or thematic NFOs offer limited scope for diversification. In other words, the fortune of these funds is closely linked with that of the sector or theme.

    If the respective sector or theme does not perform as expected, the returns are not compensated by another sector. This, in turn, weighs on the performance of such funds.

    Then there are NFOs with a market capitalisation bias. They have mandates to invest in large-cap stocks, mid-cap stocks, or small-cap stocks. The performance of such funds is subject to the kind of stocks held in the respective marketcap segments.

    Each of these segments has distinctive risk-return traits. You need to prudently recognise which of these are best suited for you under different market conditions. Don't follow the herd.
  5. Expense ratio and other associated costs

    To manage a fund, whether it is new or old, there are associated costs - marketing expenses, registrar and transfer fees, maintaining proper records of investors, custodian charges, legal and audit fees, brokerage on buying and selling securities, fund management expenses, etc.

    These are subsumed under the Total Expense Ratio (TER) of the fund.

    As an investor, you don't pay this fee directly to the fund house. The fee is calculated on a daily basis as a percentage of the scheme's total assets. It's then adjusted to the Net Asset Value (NAV) of the fund.

    Usually, in the case of new funds, particularly those which are actively managed, the TER is higher. In other words, you may pay a higher expense ratio. Check if the expense ratio is lower or equal to the SEBI guidelines.

    It is beneficial to keep the cost of investing low. Otherwise, it may weigh down on your potential returns. That being said, it is not that funds with the least expense ratio are the best. What matters is how well the portfolio is constructed and managed.

To conclude...

To form an opinion about the viability of the NFO, you must carefully examine all the documents relating to the scheme.

For a mutual fund to be a worthwhile addition to your portfolio, your investment objectives must coincide with its goals.

If you discover the new fund offer is merely a repetition of a current strategy - 'Old wine in a New bottle' - then give it a miss. Whatever is offered - NFO, IPO, or investment advice - in the words of Euripides, "Question everything".

This will help you steer clear from opportunistic fund houses, their relationship managers, and mutual fund distributors/investor advisors who consider you to be a fool and want to grow their business at your cost.

Consider only those NFOs that offer a unique proposition and suit your investment needs.

Happy Investing!

Disclaimer:This article has been authored by PersonalFN exclusively for Equitymaster.com. PersonalFN is a Mumbai-based Financial Planning and Mutual Fund research firm known for offering unbiased and honest opinions on investing.

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