NFO vs Existing Mutual Funds: Investment Choice

Many investors face the dilemma of choosing between a New Fund Offer (NFO) and an existing mutual fund. Understanding the nuances of NFOs and existing mutual funds is crucial as this choice can significantly impact your investment portfolio's growth trajectory.

This blog aims to simplify this choice. We'll briefly understand what NFOs are and explore whether one should invest in NFOs or existing mutual funds, highlighting both their strengths and limitations.

What is an NFO?

A New Fund Offer (NFO) is a mutual fund's debut on the market, similar to an IPO in the stock world. The NFO is launched by Asset Management Companies (AMCs) to provide fresh investment opportunities to investors or capitalize on upcoming market growth.

According to SEBI's regulations, an NFO can be open for subscription for a maximum of 30 days. During the NFO period, investors can purchase units at a base price. After this period, the fund operates like any other mutual fund, with fluctuating unit prices based on market movements.

Types of NFOs

NFOs are broadly classified into two categories: close-ended and open-ended schemes.

1. Close-ended Schemes: These funds have a fixed maturity period. Investors can invest in them only during the NFO period. Post-NFO, these funds are listed on stock exchanges, where investors can buy or sell units. However, the liquidity can be lower compared to open-ended schemes.
2. Open-ended Schemes: These do not have a fixed maturity. Investors can buy or sell units at any time post the NFO period at the prevailing Net Asset Value (NAV). These schemes offer higher liquidity and flexibility compared to close-ended ones.

Should You Invest in NFOs?

Investing in NFOs has its unique set of advantages and risks.

Positives of Investing in NFOs:

1. Diversification: NFOs may introduce new strategies or fund types that were previously unavailable, providing diversification benefits and the potential for higher returns in unexplored market segments.
2. Access to New Market Opportunities: NFOs are often aligned with emerging market trends. They offer an opportunity to invest in a sector or theme that's gaining momentum, potentially leading to higher returns as the trend matures.
3. Attractive Entry Price: NFOs typically have a lower entry price, usually around INR 10 per unit. This makes them more accessible and allows investors to buy more units with a smaller investment.

Why You Should Not Invest in NFOs:

1. Absence of Performance History: NFOs, being new, lack historical data on returns and fund manager performance. This makes it challenging to predict how the fund will perform in different market conditions.
2. Market Timing Risks: The success of an NFO can be highly dependent on market conditions at the time of launch. If the market conditions deteriorate shortly after the launch, the NFO could underperform.
3. Limited Information on Portfolio Allocation: In the initial stages, the fund's portfolio is not fully invested, making it difficult to estimate its risk and return.

Should You Invest in Existing Schemes?

Existing mutual fund schemes come with their history and established processes, which present both advantages and challenges.

Positives of Investing in Existing Mutual Funds:

1. Established Performance Record: Existing funds provide historical data on returns and volatility, offering a clearer picture of their performance across different market cycles.
2. Diversified and Established Portfolio: These funds have an already diversified portfolio, which reduces the initial risk associated with market fluctuations and fund manager decisions.
3. Variety of Choices Based on Track Record: Investors have the luxury of choosing from a wide range of established funds based on various criteria like past performance, risk-adjusted returns, and the fund manager's expertise.

Disadvantages of Investing in Existing Funds:

1. Potentially Higher Entry Cost: The NAV of existing funds can be higher, which might lead to a higher entry cost for investors, particularly in funds that have performed well historically.
2. Risk of Market Saturation: In a saturated market, finding unique opportunities becomes challenging, and some funds may not offer innovative investment strategies. This saturation can limit the opportunities for diversification and exposure to new growth areas, potentially leading to overlapping investments that don't significantly enhance your portfolio's performance.
3. Possibility of Performance Plateaus: Established funds, especially those with a long history of strong performance, may face periods of stagnation. There's a chance that funds which have been very successful in the past may reach a point where their growth slows down. While they're stable, their potential for significant future gains might be less than newer funds.

Key Takeaways

• NFOs offer new opportunities and potentially innovative strategies but lack historical performance data. In contrast, existing funds provide a track record and established portfolios but may come with higher entry costs and potential market saturation.
• NFOs can be riskier due to the absence of performance history, making them more suitable for investors who are comfortable with uncertainty and looking for new market opportunities. Existing funds, with their performance track record, might be preferable for those seeking stability and proven strategies.
• The success of an NFO is often linked to market timing and its underlying strategy, which can be a double-edged sword. Existing funds offer the advantage of established strategies and diversification. However, they may face performance plateaus and limited growth in saturated markets.
• Your choice between NFOs and existing funds should align with your investment goals, risk tolerance, and investment horizon. NFOs might be more appealing for long-term growth prospects in new sectors. While existing funds are suitable for steady growth and risk mitigation.
• Regardless of the choice, thorough research and due diligence are crucial. Assessing fund management quality, investment strategy, and market conditions are essential steps in making an informed decision.