Often many new investors get attracted to New Fund Offers (NFOs). Please tell the readers what exactly is an NFO.

Chirag Muni: So, NFO is nothing but a new fund offer. It is specifically issued by asset management companies, which are our mutual fund houses. Whenever they want to raise money for a specific scheme that they want to launch, then they come out with what is called a new fund offer. This is like a new subscription. There is a new theme around it. There could be several categories. It could be for equity, for debt, for any scheme that the asset management companies want to raise money for, so that is called a new fund offer. It is somewhat similar to an IPO, not exactly like an IPO, like how we do subscriptions to a new issue. It is like doing a subscription to a new scheme of the asset management company.

What are the factors that an investor should consider while investing in a New Fund Offer?
Chirag Muni: You must check these 3 things before investing in an NFO.

Fund House Reputation: Established fund houses with at least 7–10-year historical track records should be considered.

Fund Objectives: Reading the SID (scheme information document) is important, this contains information such as investment objective, asset allocation pattern, investment strategy, profile of the fund manager, benchmark index, etc. SAI (statement of additional information) exhibits all the statutory and other information about the AMC.

SID gives you the details about who is the fund manager, the profile of the fund manager, what is the benchmark they are going to use, what is the asset allocation strategy that the fund manager is likely to use, what is the objective of the fund, so on and so forth. SAI will give you more operational details of the AMC, the asset management company, and of the scheme, etc. So, these are the two documents one should go through before looking at the NFO.

Cost of Investment: There is no entry load, however, some NFOs charge exit loads if you happen to redeem units before the completion of the tenure. If the lock-in period is longer than your investment horizon, then your returns can be affected on account of the exit loads.

What are some of the cons and biggest misconceptions when it comes to investing in NFOs?
Chirag Muni: The single biggest con of an NFO is that there is no track record because it is a new scheme. Of course, the fund house may have some track record and you may go based on what the other schemes of the fund house have done but that may or may not be the right approach because you are looking at the historical return of other schemes, number one. Number two, you are also looking at a scheme which is newly launched. Now, what is that investment strategy? What are the new challenges that the fund manager might now have when he is going to invest could be completely different. So, it is like you are just trusting the fund house and the fund manager that they will do a good job but there is no track record.Also, there is no additional benefit of investing in NFO. If there was a benefit that you are getting a cheaper price of the NAV, then it is a different story but that is not the way a mutual fund house works. While the NAV could be smaller, which is Rs 10, usually that is the issue price but that does not mean that you are buying it cheaper. It is just the starting price because ultimately, the NFO is… the returns will depend on the underlying investments that the fund house will do.

The third mistake is the timing of the scheme. For example, there are 11 categories of equity mutual funds today like largecap, midcap, large and midcap, smallcap, flexicap, thematic, ELSS etc. Now, not necessarily all the 45 asset management companies that we have today have completed their portfolio in each of these categories because what SEBI says, as per Circular of 2017, is that every fund house should have only one scheme in each category. There is a possibility that a fund house has not yet launched a midcap fund. So, to finish their product portfolio, they are just launching a scheme. If the fund house is launching in midcap, doesn’t mean midcap is likely to do well. So, it is a fund house objective and not your objective. The launch timing does not correlate with what you should invest in.

Since there is no past performance, how can one review the performance of NFOs then?
Chirag Muni: Very difficult. You are trusting the fund manager and the fund house. If you analyze the performance of the recent NFOs that have been launched, there were about 43 NFOs launched in 2023, 31 of them have not even given a 6% return and 14 of them have given a negative return.

Again, if we look at 2024, 33 out of 68 NFOs have completed one year but they have failed to beat their own benchmarks. So, there is quite a divergence because they are completely new and all are different categories. If I have to give an example, last year itself, the bottom three average negative returns were about 35-40% and the top three were about 45% to 75% in the range. So, there is a divergence of almost 118% between the best and the worst which is also generally in other categories.

Are NFOs cheaper?
Chirag Muni: NFO units are typically priced at Rs. 10, but this can be misleading. The actual cost is determined by the expense ratio and investment returns. Starting a new fund involves marketing costs and other variables, which can make NFOs more expensive than existing funds.

You can only invest in an NFO during the launch period.
Chirag Muni: While initial subscription is limited, NFOs often become open-ended funds after closing. Monitoring performance post-launch and comparing it with other schemes helps make informed decisions based on market conditions.

Should investors invest in NFOs?
Chirag Muni: Investors should carefully consider whether to invest in NFOs as it has its risks and uncertainties. NFOs might look exciting in the first go but our suggestion would be to wait and watch NFOs before diving in as they do not have any background data to analyze. Opt for diversified funds instead and maintain a market cap allocation of 50:20:30 in Large, mid and small-cap. This will help you ride all market cycles.