What is NFO: Meaning, Types, Benefits & How it Works

If you have just started investing in mutual funds, then you must have come across the term NFO. You must have seen various advertisements by mutual fund houses announcing that a new NFO has opened up for investment. What exactly is an NFO, and is it worth investing in an NFO?

NFO stands for New Fund Offer. It is the initial subscription period of a newly launched mutual fund scheme by an AMC. During this period, investors can apply for units of the newly launched scheme. SEBI defines NFO as the first-time subscription offer of a new mutual fund scheme.

At first impression, you might think that NFO is similar to IPO because both are new offerings. But NFO and IPO are very different. NFO is a mutual fund scheme, whereas IPO is an offer to buy shares of a company. In this article, we will explain what NFOs in mutual funds are, how they work, their benefits, risks, and more.

What is an NFO in a Mutual Fund?

NFO refers to the initial subscription period when a mutual fund company launches a new scheme and invites investors to invest in it.

During the NFO period, investors can subscribe to units at the NFO price, which usually comes to ₹10 per unit in India. Once the NFO period ends and the scheme starts operations, then the units can be bought and sold based on their NAV, subject to the scheme’s terms.

Let us understand this with an example:

ABC Mutual Fund introduces a new equity mutual fund. The NFO price is ₹10 per unit. If you invest ₹10,000 during the NFO period, you will receive 1,000 units of the mutual fund, without considering any other charges.

However, one must note the following:

A lower NFO price does not indicate that the mutual fund is cheaper or gives higher returns.

It is one of the most common misconceptions regarding NFOs. A mutual fund with an NFO price of ₹10 is not necessarily a better investment option than an existing mutual fund with an NAV of ₹100 or ₹200. The value of a mutual fund depends on its investment strategy, portfolio, costs, risks, management, and suitability, not just the price of its units.

Types of NFO in India

New fund offers are generally introduced through open-ended or close-ended mutual fund schemes.

Open-Ended Funds

An open-ended fund allows investors to purchase or redeem units from the fund after the NFO closes. The number of units keeps fluctuating based on investors’ purchases and redemptions, and these transactions take place at the fund’s applicable NAV.

Close-Ended Funds

A close-ended fund has a fixed number of units and a fixed maturity period. Once the NFO is closed, the investors are not allowed to purchase or redeem units directly from the fund. If listed, the units can be purchased or sold on the stock exchange and may be traded at a premium or discount to the NAV of the fund depending upon the demand and supply.

For example, if the NAV of a close-ended fund is ₹12 but its units are being sold at ₹15 on the stock exchange, the fund is said to be trading at a premium. If its market value drops to ₹8, then it is said to be trading at a discount.

Both open-end and close-end schemes can have potential for capital appreciation and income generation, depending on the scheme and its underlying investments.

How Does an NFO Work?

The working process of an NFO is very simple:

AMC Launches a New Scheme

The Asset Management Company launches a new mutual fund scheme. The scheme has a certain investment objective. For instance, an AMC may launch schemes like:

• Large-cap fund
• Mid-cap fund
• Small-cap fund
• Flexi-cap fund
• Debt fund
• Hybrid fund
• Sectoral fund
• Thematic fund
• Index fund
• Fund of Fund

The scheme documents provide details of how and where the fund proposes to invest.

NFO Opens for Subscription

The AMC announces the opening and closing dates of the NFO. During this period, investors can apply for the scheme. Under the existing regulations, an NFO is open for subscription for a limited period. The scheme documents usually specify a minimum of three working days and a maximum of 15 days, in accordance with SEBI guidelines.

Investors Invest in Units

During this period, you can invest the required amount through the various investment modes. The amount you invest is pooled with the money collected from other investors.

Units Are Allotted

Once the NFO closes, the units are allotted according to the applicable terms. The money collected is then invested in accordance with the scheme’s investment objective.

The Fund Starts Operations

Once the scheme starts, the fund manager invests the money in securities such as stocks, bonds, government securities, or other permitted investments, in accordance with SEBI guidelines.

How to Invest in NFO?

Investing in an NFO is relatively similar to investing in a mutual fund scheme. Here are the steps that you can follow while investing in an NFO:

Step 1: Select the NFO

Firstly, evaluate the NFO and understand its investment objective, investment strategy, risk factors, benchmark, costs, and other necessary details.

Step 2: Verify the NFO Details

Before investing in the NFO, verify the subscription period, minimum investment, and other details of the NFO.

Step 3: Complete KYC Compliance

Make sure that you have completed the applicable KYC compliance. However, if you are already KYC-compliant, you may not need to complete the process again, subject to applicable rules.

Step 4: Subscribe to NFO During Subscription Period

During the subscription period, you can subscribe to the NFO via an eligible investment platform, AMC, or any other eligible means.

Step 5: Invest in NFO

Once you choose the NFO, enter the investment details, select the investment amount, and pay the money via the available payment option.

Step 6: Get Units Allotted

Once the NFO subscription period ends, the fund house will process your application and allot the units accordingly.

Step 7: Monitor Your Investment

Post allocation of units, you can monitor your investment through the investment platform, AMC, or any other relevant account statement.

Benefits of Investing in an NFO

There are certain benefits associated with investing in an NFO, depending on the scheme and the investor’s needs.

• Access to a New Investment Strategy: The biggest benefit of an NFO is that it can help investors to participate in a novel investment strategy. In other words, the AMC can issue an NFO based on a specific theme, index, or investment strategy that appeals to the investor.
• Opportunity to Invest from the Beginning: Some investors prefer investing in schemes that have just been launched. Investors receive units of the scheme during the initial offer period and participate in the fund’s journey right from the start. However, being an early investor does not necessarily mean that they will earn high returns.
• Potentially Unique Portfolio: The new scheme can have a unique portfolio or investment strategy compared to other existing funds. It can be helpful for investors as it may fit their asset allocation strategy.
• Professional Fund Management: Like any other mutual fund scheme, the NFO is professionally managed according to its investment objective by fund managers and AMC. The investor does not need to choose individual securities of the portfolio themselves.
• Diversification: Based on the nature of the NFO, the scheme can invest in several securities. It can help in diversifying the investment as compared to investing in one or a few securities.

Limitations and Risks of Investing in NFO

Apart from the advantages, NFOs also carry certain risks. One of the key points to keep in mind is that a new mutual fund does not have a track record of performance.

• No Long-Term Track Record: The existing mutual fund may have several years of performance history, whereas a newly launched NFO does not have a track record. You cannot assess how the fund has performed over the past five or ten years because it has not been in operation for that long. In this case, you need to assess the investment strategy, fund manager, AMC, benchmark, and other details.
• ₹10 NAV Does Not Mean Cheap: This is the most common misconception about NFOs. For example, let us assume that Fund A has an NAV of ₹10 and Fund B has an NAV of ₹100. It does not mean that Fund A is cheaper. Both funds may have similar portfolios, and if Fund A grows by 10%, the NAV can grow from ₹10 to ₹11. In the same way, the fund with ₹100 NAV can grow to ₹110 on a 10% increase. Percentage return is more important than the starting NAV.
• Higher Risk in Some New Strategies: Sometimes, NFOs are launched on a specific sector, theme, or strategy. Certain NFOs may carry greater risk depending on their mandate. An interesting idea does not necessarily mean that it will be a profitable investment.
• Limited Information About Actual Portfolio: Before the launch, the fund has not yet constructed its entire portfolio. Although the scheme documents provide information about the investment strategy, the actual portfolio may differ from the strategy described.
• Lock-In May Apply: Not every NFO has a lock-in, but certain schemes may have one depending on their structure. For example, certain tax-saving mutual fund schemes have a statutory lock-in period. So, it is always advisable to check the scheme documents before investing.

Common Myths Associated with NFOs

Myth 1: NFOs are cheaper than existing mutual funds

This is a myth. An NFO priced at ₹10 cannot necessarily be considered cheaper than an existing fund of ₹100 NAV.

Myth 2: NFOs always give higher returns

This is a myth. It is never guaranteed that the new scheme will provide better returns than the old one.

Myth 3: NFOs are like IPOs

Not really. They have different structures and purposes.

Myth 4: Every new NFO should be purchased

This is a myth. Buy an NFO only if its strategy suits your financial goals.

Difference Between NFO and Mutual Funds

FAQs

What is NFO in a mutual fund?

NFO stands for New Fund Offer. It refers to the initial subscription period when a mutual fund company launches a new mutual fund scheme and invites investors to invest in it.

Is investing in an NFO better than an existing mutual fund?

Not necessarily. An NFO may offer a new investment strategy, but an existing mutual fund has a track record that can help investors evaluate its performance, risk, and portfolio.

Is an NFO available at ₹10 per unit?

Many NFOs are offered at ₹10 per unit, but this does not mean the fund is cheaper than an existing mutual fund with a higher NAV. The NAV itself does not determine whether a mutual fund is cheap or expensive.

Do NFOs guarantee higher returns?

No. NFOs do not guarantee higher returns. Their performance depends on the securities in which the fund invests, market conditions, and the fund's investment strategy.

What is the difference between an NFO and an IPO?

An NFO is the initial offering of units of a new mutual fund scheme, while an IPO is an offering through which investors can buy shares of a company. They have different structures and purposes.

Can beginners invest in an NFO?

Yes, beginners can invest in an NFO if the scheme suits their financial goals, risk tolerance, and investment horizon. However, they should understand the fund's strategy and risks before investing.

How can I investing in an NFO?

You can invest in an NFO through the AMC, eligible mutual fund platforms, and other permitted investment channels during the NFO subscription period. The exact process and minimum investment amount can vary between schemes.

What should I check before investing in an NFO?

Before investing, check the fund's investment objective, strategy, risk level, benchmark, expense ratio, exit load, lock-in conditions, and fund manager. Also consider whether the NFO adds value to your existing investment portfolio.