New Fund Offer
Over the past few years, mutual funds have caught the fancy of retail investors. There are several reasons for this popularity. One is that it’s very easy to invest in mutual funds. Two, people can leave the hard work of investing to professional managers who are much better at it than they can ever hope to be. Three, mutual funds are liquid and can be bought and sold easily. Four, investors are able to get a varied mix of stocks of different market caps and sectors, and also a variety of fixed income instruments like government bonds, non-convertible debentures of companies and so on.
So what’s the process behind the starting of a mutual fund? Well, mutual funds start off in the same way as shares, with a new fund offer, or NFO. These are similar to initial public offers or IPOs that companies come out with when they make an offer of shares to the public for the first time before getting listed on the stock exchange. Similarly, mutual fund houses come out with a new fund offer to invest in equity, bonds etc for the investing public. So how does the entire process take place?
Once a fund house decides to introduce a new scheme, it comes out with an NFO. The fund lays down the objectives of the offer. For example, it specifies what the new scheme hopes to achieve – whether it wants to invest in a specific sector, size of share (large cap, small cap, mid cap) and so on. After that, the fund house makes its offer to the public. These mutual funds can be accompanied by high-profile marketing campaigns, making claims that the investing public should verify before committing any funds.
NFOs and open-ended funds
The offer remains open for a limited amount of time, after which it is closed for further investment. There is a difference between open-ended funds and close-ended funds after the completion of the NFO process. In an open-ended fund, the fund house does not seek a fixed amount for the scheme. After the initial offer, the scheme remains open for further investment for an indefinite time. There is also no cap on the amount that can be invested in the scheme. It is for this reason that these mutual funds are called open-ended.
Investors can buy and redeem units at any point of time. Unlike shares, open-ended mutual funds are not listed on any exchange, and investors buy and sell units directly from the company managing the funds. The price at which investors buy and sell units of a fund is called net asset value or NAV. NAV is the current net value of the fund’s assets divided by the total number of units outstanding. Mutual fund companies are required by law to fix the price of their shares each business day.
NFOs and close-ended funds
Things are a little different with a close-ended fund. In this case, the NFO is open for a limited period of time and the amount that it seeks to raise from investors is also fixed. After the offer is closed, the fund house does not accept any more investments in this scheme. Investors too won’t be able to redeem funds until a specified maturity period.
However, the close-ended fund scheme will then be listed on the stock exchange, where it is bought and sold like shares on an everyday basis. The price of the mutual fund will then be determined on the exchange according to demand and supply. Demand will depend on earnings expectations from the scheme. If the scheme is expected to do better than expected, the price will rise. If not, the price will fall. The price of the units of the scheme may be higher or lower than NAV depending on demand. It could trade either at a discount or at a premium.
Why NFO mutual funds?
Why should investors go in for NFO mutual funds? As we have mentioned earlier, mutual funds are very popular with retailer investors and many will be willing to invest in a new fund. The enthusiasm is at its peak when the stock markets hit new highs and investors are willing to put money in anything that resembles a money-making opportunity.
Generally, in most cases, fund houses price the NFO at a discount to attract investors, and it does work much of the time. Investors see the low price as a buying opportunity and go for it. Of course, mutual fund investments carry market risk, and sometimes investors get carried away by the marketing hype and invest in funds that may make sub-par returns in the future.
How to invest
Unknown territory: There are always risks involved in mutual fund investing. In an equity fund, prices could go up and down and affect your returns. Debt funds involve interest rate risk and changes in rates could lead to losses. There is an additional risk involved in these funds, and that is the lack of any kind of the previous record. Investors here are entering unknown territory since the scheme will have no previous history of profits or losses. This is unlike existing funds, which can be easily gauged based on past performance. Of course, as the pundits are quick to point out: past performance is no guarantee of future returns.
Fund house: Records of past performance may be unavailable with these funds, but there will certainly be a record of a fund house. If you must invest in a new fund, consider the fund house’s record before investing. If the fund house has been in the business for a long time and its schemes have a record of earning good returns for its investors, you may not be overly concerned about the fund’s performance. If it’s a new fund house that’s coming out with an offer, you should be more alert.
Objectives of the fund: There may be a temptation on the part of some investors to rush into an NFO just because of the marketing hype and the hope of getting units at a discount. But it’s always better to take a more measured approach and see if the fund meets your investment objectives. For example, if you are a risk taker, it might not make much sense to invest in a fund that seeks to invest in large-cap shares which involve less risk, but offer lower returns than mid-cap shares. The prospectus will give detailed information about the scheme’s objectives. Take a close look at them and find out if they are in tune with your investment objectives.
Is it different: It does not really make much sense to invest in a fund that sells the same old wine in a new bottle. In the case of older funds, you at least have a previous track record to gauge performance. In the case of new funds, there is no track record. So invest in them only if the fund house is offering something different or innovative.
Fund manager: These funds don’t have any past record so you can’t use that to gauge performance. But there’s one thing you could do, and that is to check the record of the fund manager. If the fund manager has had a good record of managing funds earlier, there’s a good chance that he could repeat that performance with the new fund as well.
Expense ratio: Expense ratio will make a significant difference to your investments since it’s a recurring cost and high costs will reduce your returns. Make sure the NFO mutual fund has a low expense ratio.
Size of the fund: The size of the fund also matters. If it is unable to collect adequate funds, its asset base will be smaller. Since there is a fixed component in the costs of managing a mutual fund, each investor will have to bear a higher burden if the asset base is of a smaller size. The result will be a higher expense ratio.
Close ended fund: Investing in these funds may make sense if they are close-ended. Since these funds do not face redemption pressures, fund managers will be able to manage them better and they might be able to make better returns in a volatile market.
Check the timing: Many fund houses launch NFO mutual funds when the stock market is on a bull run and investor sentiment is upbeat. However, there’s a downside to this kind of timing. Fund managers may have to pick up stocks at a higher price while building portfolios. So in the longer run, you may have to settle for lower returns.
How to invest: You can invest in new fund offers through your broker or online trading account. Download the AngelBEE mutual invest app to invest in mutual funds, including equity, debt and balanced funds.