NFO or Mutual Fund: Key Differences

Factors to be considered while investing in an NFO:

With the rapid rise in the number of retail investors in the Indian equity markets, public interest in the markets is at an all-time high. Many investors are also choosing to go through the indirect route of making investments, which is through mutual funds. There also exists a lot of ambiguity amongst investors regarding whether to invest in existing mutual fund schemes or in New Fund Offers, also known as NFOs. In this article, we will try to compare whether one should invest in mutual funds or apply for NFOs.

Let’s start by defining what is an NFO.

What is an NFO?

An NFO, or a New Fund Offering, is a new mutual fund scheme with a new investment objective which is being offered to investors by an Asset Management Company (AMC). An AMC can launch an NFO only if they don’t have any scheme with a similar investment objective. NFOs are of two types:

Close-ended funds: Available for purchasing during NFO and can be redeemed only at the maturity of the fund.

Open-ended funds: Available for selling and purchasing all the time

According to SEBI, t

• An NFO can stay open for a maximum of 15 days for investors participation
• In India, the price is usually set as 10 rupees per unit of the mutual fund
• Once the NFO period ends, investors can only buy the units of the scheme at a prevailing NAV for open-ended mutual funds. In the case of closed-ended funds, you can’t buy the units after the closing of the NFO. 

Difference Between NFO and MF:

One feature which differentiates mutual funds from NFOs is that mutual funds have an existing track record in the form of performance as compared to a benchmark, returns delivered and the consistency, which a newly offered fund or NFOs does not have.

Pros and Cons of NFOs

Pros: They encourage investors to try their hands at new investment strategies and themes which have not been explored previously by the AMC.

Cons:  1. They have no proven track record, unlike their existing mutual fund counterparts, who have an entire background history of their performance against benchmark returns over multiple market cycles. This significantly increases the risk factor associated with New Fund Offers.

2. New Fund Offers tend to come with higher initial expenses. When AMC come up with new funds the marketing costs are considerably high and they tend to recover the capital invested from their investors by passing on the cost to them in the form of a comparatively higher expense ratio

Factors to be considered while investing in an NFO:

1. Risk appetite of the investor 

2. The reputation of the Asset Management Company 

Why You Should Not Invest in NFOs

New Fund Offers (NFOs) can be tempting, but before you jump in, consider these drawbacks:

1. No Past Performance: Unlike established funds, NFOs are brand new. You can't track how they've performed in different markets, making it risky.
2. Not Like IPOs: NFOs aren't cheap just because they're new. The price you see (NAV) is the starting point, not a discount.
3. Higher Fees: Launching a fund takes effort, and those costs might be reflected in fees that eat into your returns.
4. Questionable Timing: Sometimes, NFOs are launched to fill a gap in a company's offerings, not because it's the best investment for you.
5. Limited Liquidity: You can't buy and sell NFO units right away. They need to launch and list on exchanges first.

Why Should You Invest in Existing Mutual Funds?

1. Track Record: Check past performance to gauge reliability.
2. Stability: Established funds offer more stability.
3. Management: Experienced fund managers often lead existing funds.
4. Risk: A diversified portfolio reduces risk.
5. Flexibility: Easy to switch or redeem units.

Investing in existing mutual funds can be a smart choice.

Pros and Cons of Existing Mutual Funds

Pros:

1. Proven Performance: You can judge the performance of the fund over time by its past.
2. Experienced Management: Most of the existing mutual funds would have fund managers who are experienced and have a good track record.
3. Stability: Established funds mostly exhibit more stability as compared to new funds.
4. Performance History: You can have access to historical data to make informed decisions.
5. Lower Risk: The risk can be reduced by diversified portfolios in the existing funds.

Cons:

1. Higher Entry Cost: Existing funds might have higher NAV (Net Asset Value), making initial investment costlier.
2. Potential for Lower Returns: Established funds might not offer the same growth potential as new, high-growth funds.
3. Performance Decline: Past performance does not guarantee future results, and some funds may underperform over time.
4. Less Flexibility: Some existing funds might have restrictions or higher fees for switching or redeeming units.

Investing in existing mutual funds has its advantages and drawbacks. Evaluate carefully before deciding.

Conclusion

All these factors which we discussed must be weighed in while investors decide to invest in NFOs, and their personal discretion along with their risk appetite matters a lot while making such decisions.

FAQs

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

Yes, NFOs can be of higher risk. They are new, so you can't track their past performance. Existing funds have some history, which allows you to see how they've done in different markets. This will help you get into a fund that has a good record and at the same time, suits your risk comfort level.

Can the high NAV of an existing mutual fund impact my returns?

No, a high NAV itself doesn't affect returns. It just means each unit costs more. Focus on the fund's performance and fees, not the NAV, to judge how much you might earn.

How important is market timing when investing in an NFO?

With NFOs, the timing of the market is relatively less of an issue because they are new products and hence don't get into this short-term market gain philosophy. See the investment strategy of the fund, its long-term goals, and whether it will align with your investment’s horizon.

Are existing mutual funds better for risk-averse investors?

Generally, yes. Most mutual funds have a track record, so that you can possibly see how they managed the market ups and downs. This enables you to choose a fund with lower risk that aligns with your focus on capital preservation.

What should I consider before investing in an NFO?

Check whether the fund house has a sound track record and if it fits the Fund's objectives, especially their fees before putting one's money into the NFO. Since the NFO itself will have no history, look for a well-established company with experience in running similar funds.

How does market saturation affect existing mutual funds?

Market saturation can make it harder for existing mutual funds to find unique investment opportunities. This could lead to more funds with similar strategies, potentially affecting returns if they're all competing for the same assets.

What does a performance plateau in a mutual fund mean?

A performance plateau in a mutual fund means its returns have flatlined for a while. The fund's value isn't necessarily dropping, but it's not growing either. This could be due to a stagnant market or the fund's strategy not capitalizing on current trends.