Q1. I'm a 28-year-old government officer, my wife is also a government officer. We have been investing in government saving schemes like the Public Provident Fund. Employee Provident Fund, etc., regularly. We have a growing family and we now wish to diversify to mutual funds. We see a lot of advertisements in relation to New Fund Offer (NFO). We wish to understand what an NFO is and whether it is better to invest in a mutual fund through NFO or if we should buy units of an already existing mutual fund.
Chaju Ram Saini, Ajmer, Rajasthan
A mutual fund house/asset management company introduces a new mutual fund through a process called New Fund Offer. The process is very much similar to the Initial Public Offer (IPO) of a company. A company collects funds from the public investor through an IPO and issues shares in exchange, similarly, through a NFO, a fund house gathers funds from public investors and issues mutual fund units in exchange.
The mutual fund house issues a document containing pertinent information in relation to the NFO, for example, the investment objective, details about the fund managers, risks associated with investing in the mutual fund scheme etc., this document is called Scheme Information Document (SID).
How does an NFO work?
The mutual fund house first files the draft SID with Securities and Exchange Board of India (SEBI). SEBI thereafter gives its comments. Once SEBI’s comments are incorporated, the final SID is filed with the SEBI. SID is akin to red herring prospectus filed in case of an IPO and contains all critical information in relation to the proposed mutual fund scheme. It is strongly recommended that investors go through the SID in detail before making any investment decision.
NFOs typically have a subscription period of only 15 days except for certain categories of mutual funds such as ELSS mutual funds. Units of a mutual fund typically are priced at ₹10 during the NFO period. Once the NFO closes the price of the units of the mutual fund will depend on the net asset value of the assets purchased by the mutual fund. In simple terms, once the NFO closes the price of mutual fund units will depend on the performance of shares, debentures, bonds etc., in which the mutual fund has invested.
What are various NFO types?
NFOs can be broadly divided into two categories: close-ended funds NFOs and open-ended funds NFOs depending on the type of mutual fund that is being introduced.
However, first let’s understand the difference between open-ended and closed-ended mutual funds before we understand the difference between their NFOs.
What are open-ended mutual funds?
These mutual fund schemes continuously issue and redeem mutual fund units, allowing investors to participate and exit the mutual fund scheme as the investors see fit. More importantly, these mutual fund schemes are not time-bound and exist perpetually. You can purchase fresh/new units of these mutual funds even after the NFO subscription period is over. The number of mutual fund units for these funds is not limited or pre-determined. Every time the asset management company (mutual fund house) issues or redeems the mutual fund units, the number of total units of that mutual fund scheme changes. The total capital of an open-ended scheme varies from day to day for this reason.
What are close-ended mutual funds?
Close-ended mutual funds issue a definite number of mutual fund units, the mutual fund scheme runs for a definite number of years and is not perpetual hence the name close-ended. Close-ended mutual funds provide two exit options to the investors:
(a) Either they choose to redeem the units of the mutual fund during periodic exit windows provided by the mutual fund house (frequency of these exit windows can be quarterly, yearly or semi-annually depending on the investment strategy of the AMC).
(b) In case the close-ended mutual fund scheme is listed on the stock exchange the units of the schemes can be sold to other investors at any time, depending on the liquidity of the mutual fund units.
Essentially, close-ended mutual funds offer much lower liquidity when compared to open ended mutual funds. It is important to note here that a majority of the close-ended mutual funds schemes are listed on the stock exchange, this allows investors an exit option as they can sell their units to other interested parties on the stock exchange.
NFO for close-ended funds
As mentioned above the corpus of closed-ended mutual fund schemes is predetermined. Once the NFO's subscription period is over, the number of units in the fund stays the same except for any redemption done during the periodic redemption windows. If the fund is listed on the stock exchange, the market price of the units is established based on the overall supply and demand. Further, in case of listed close-ended mutual fund schemes the number of units remains the same throughout the tenure of the mutual fund scheme.
NFO for open-ended funds
One can buy the units of an open-ended fund even after the NFO subscription period. However, as mentioned above the mutual funds units will typically be available at a cost of ₹10 during the NFO period, however, once the NFO is over the price of the units will depend on the performance of the mutual fund.
Though past performance does not guarantee the future performance of a mutual fund, it is an important factor to assess how good a particular mutual fund is when making an investment decision. In the case of NFO data points in relation to past performance are missing consequently making the investment decision-making process difficult for the investor. However, it is important to note that most new mutual funds target an area of the economy which has been historically closed to retail investors.
For example in the past 2 years multiple mutual funds targeting the electric vehicle industry have been launched. If an investor wants to put his money in an unexplored sector more often than not investing through an NFO is the only option available to them.
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Note: This story is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.