💰 NFOs: Should You Invest?

Welcome to this week’s issue of Altsights - your weekly dose of incisive investing insights!

Today’s investing insight is an important one, so let’s dive straight into it!

More than 100 NFOs have been launched in the first half of 2024 with many more lined up in the coming months.

But what on earth are NFOs and should you invest in them? 🤔

Understanding NFOs 💭

New Fund Offer a.k.a NFO is how mutual fund schemes are born.

When a mutual fund wants to launch a new scheme, it offers an NFO to investors to collect money and bring the mutual fund scheme to life.

NFOs 🤝🏼 Bull Runs

This isn't the first time NFOs are being launched left, right and centre.

We've seen a few periods when NFOs were launched by the dozens and managed to collect thousands of crores.

These NFO mania periods, including the one we’re witnessing today, coincide with the biggest bull runs in the stock market.

For instance, we saw the mother of all bull runs from 2004 to 2007. The NIFTY 50 went up by over 200% during this period. 230+ NFOs were launched from 2004 to 2009 that collected well over ₹1 lakh crore.

Simply put: Mutual funds take advantage of investor confidence during bull runs to launch NFOs and collect more money.

NFO Myths You Should Not Believe In 🔮

Investors invest in NFOs for all the wrong reasons. Here are a couple of them:

Low ₹10 NAV Will Generate High Returns ❌

Mutual fund units are different from company stock.

While owning more company stock makes you a bigger owner of the company, owning more mutual fund units just because the NAV is ₹10 doesn’t make you richer.

Suppose you invest ₹1,00,000 in scheme A where NAV is ₹100. So you got 10,000 units. You also invest ₹1,000 in scheme B where NAV is ₹50 to acquire 2,000 units.

If both schemes generate a 10% return over the next 1 year, you’ll be equally well off pocketing ₹1,10,000 in both cases despite the gap in NAVs.

The rate of growth or returns matters much more than the NAV of the scheme.

Mutual Fund NFOs = Company IPOs ❌

Not at all!

An IPO involves a private company seeking funds to go public. You can subscribe to the IPO with full knowledge of the company and its business.

In contrast, an NFO collects money from investors to invest in securities like stocks, bonds etc. for a new mutual fund scheme that doesn’t exist yet.

When an NFO is introduced, there's no way of knowing what the scheme’s underlying portfolio will look like.

There are many other fundamental differences between NFOs and IPOs that if I attempt to explain would run into hundreds of words.

Long story short: NFOs are not IPOs and should be looked at from the same lens.

Should You Invest in NFOs? 💰

In most cases, NFOs should be avoided ❌

There are over 1500 mutual fund schemes already available many with long performance track records. It’s better to choose one of them for your portfolio.

I’d also recommend avoiding NFOs if all you are planning to do is invest a token amount like ₹10,000 due to FOMO or because a friend told you. This is a sure-shot recipe to complicate your investment portfolio.

You Can Consider Investing in an NFO if…

1. The NFO offers a unique fund strategy:

If the fund is set to follow a unique strategy, then investing in the NFO could be considered.

If you come across a similar NFO that offers value or diversification for your portfolio, it might be worth considering.

However, don't invest just because something is new.

2. You Have Confidence in the Fund Manager:

You can't know exactly where the NFO scheme will invest your money so you have to rely heavily on the fund manager’s reputation.

A new scheme that will be managed by an experienced fund manager with a good track record across market cycles could be considered.

I know a few investors who began investing in the Parag Parikh Tax Saver Fund (launched in 2018) to save tax because it is managed by Rajeev Thakkar.

Rajeev Thakkar has made a name for himself by consistently delivering stellar performance through the Parag Parikh Flexi Cap Fund.

3. Fund Category Benefits from a Lower Fund Size

In certain categories with low liquidity or high churn, a smaller fund size can make a big difference.

If existing funds in these categories have become very large, a small-sized NFO might be a good opportunity. For example:

• A new small-cap fund with low AUM has an advantage over a large small-cap fund due to low liquidity in small cap segment

• A new momentum strategy fund with low AUM has an advantage over a similar fund with large size as momentum strategies are easier to replicate with smaller funds

Reader’s Spotlight💡

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