What are Mutual Fund NFOs and should you invest in them?


NFO is short for New Fund Offer.

It is the process by which a Mutual Fund company gets initial investors for a new fund that it is launching.

In that sense, it is similar to the IPO of a company when it offers its shares to the public at large for the first time.

Many investors flock to subscribe to NFOs because of this similarity to IPOs.

But there is a major difference.

A stock's price on listing post-IPO is a function of its supply and demand, because of which stocks that are high in demand tend to list at substantial premiums over their IPO price and can keep going up e.g. CDSL, DMART etc.

This does not apply to Mutual Fund NFOs. There is no constraint on supply.

You give the Mutual Fund your money and it creates your units at the NFO NAV, usually Rs. 10. It can issue as many units as it wants, they are just like a receipt for accounting purpose.

Your money will then get invested in the stocks or bonds that the Fund Manager chooses according to his/her strategy and fund objectives.

The performance and subsequent NAV of this newly launched Mutual Fund, like all other Mutual Funds, will depend on how well its underlying stocks and bonds do irrespective of how successful the NFO is in getting subscriptions.

If the stocks it holds go down, the subsequent NAV will also go down and vice-versa.

Unlike stocks, there is never going to be a pop in the NAV of a NFO when it 'lists' (i.e. becomes open for subscription) simply because the sole driver of NAV of a Mutual Fund is the performance of its underlying holdings (and the expenses deducted by the fund) and not how much money got invested in the Mutual Fund.

If you have more money to invest - does it make your stock holdings jump in returns? No, right? Same thing.

Okay, so there won't be any jump in the price like it may happen with stocks. But aren't you getting it cheaper at just the NAV of Rs 10?

This is another of those myths propagated by unscrupulous agents. Smaller NAV does not equal cheaper, just like smaller stock price does not equal cheaper.

It is as difficult for NAV to go from 10 to 11 as it is to go from 100 to 110 since both require the underlying investments of the Mutual Fund to give a 10% return.

If the new units were issued at an NAV of Rs 1 or at Rs 100, it wouldn't make any difference to the performance of the fund.

After DSP Blackrock Micro-cap's NFO in early 2008 at an NAV of Rs 10, the NAV fell down to Rs 4.2 during the crash - almost a 60% drop - similar to other equity Mutual Funds which had higher NAVs.

NAV is just an accounting construct. What matters is the percentage movement and that remains the same irrespective of the NAV number.

Are there any advantages of investing in shiny new NFOs?

No.

Not only there are no advantages, in fact there are 2 distinct disadvantages of investing in an NFO:

  1. No track record - Even if you like the strategy or the managers behind the fund, why not wait till the fund proves that it can execute the strategy well, especially when you have so many other mutual funds with proven track record available.
  2. Higher expenses - Usually the expense ratio of NFOs tend to be higher since their AUM is low and all the fixed charges and marketing charges will have to be borne by the initial investors.

So overall it is better to stay away from NFOs and just stick to your MF selection strategy. If some day, that fund comes up in the selections, then go ahead with it with confidence. Until then, there are better funds to invest in.