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Investing in NFOs of mutual funds may not provide you with many benefits. Here's why

Some investors believe that purchasing a freshly launched mutual fund unit at its face value of Rs. 10 is a smart option when investing in a new fund offer (NFO). However, these investors actually thought that stocks and mutual fund units were the same thing.

Therefore, let's first define an NFO.

a fresh fund offer

'New fund offer' (NFO) is the term used when a mutual fund plan is initially made available for investment. In order for the fund manager to create a portfolio based on the investment goals of the plan, the NFO tries to amass an initial corpus. If the programme is open-ended, following the NFO period, which is typically a week to 15 days, the money will once again become available for investment.

Simply because a fund's net asset value (NAV) is low during NFO doesn't mean that an investor should invest in it. The price at which the money received during an NFO will be invested is more crucial.

Consider the scenario when there are two strategies, A and B. While units in Scheme A are brand-new and have a face value of Rs. 10, those in Scheme B have been in circulation for more than ten years and have a value of Rs. 50.

Consider that you choose to invest Rs. 50,000 in each of Schemes A and B. In scheme A, you would receive 5,000 units (50,000/10), and in scheme B, 1,000 units (50,000/50). Let's evaluate how much you would profit from both plans assuming that both provide 20% returns.

After a year, Scheme A's NAV will be Rs. 12 (Rs. 10 plus 20% of 10). After a year, Scheme B's NAV will be Rs. 60 (Rs. 50 plus 20% of 50). The final investment value for plan A will be Rs. 60,000 (12 x 5,000 units). It will also be Rs. 60,000 in plan B (Rs. 60 divided by 1,000 units). Therefore, you actually put the same amount of money into both schemes, and the final result was the same. Therefore, investing in NFOs will not benefit you in any way.

The NFO gathers new funds in a new category of funds, and mutual funds cannot have more than one fund in a category, according to Sriram Jayaraman, a Sebi-registered investment advisor and income tax planner. The majority of fund companies currently provide large-, mid-, and small-cap funds. Usually, they create a new NFO category for which they do not yet have a fund. They are thus more likely to develop a sector- or theme-based NFO. Since they are riskier than diversified funds, these sector and/or thematic investments are not advised.

The sole exception is if an investor is thinking about investing in NFOs to fill a void in their portfolio caused by a closed-end fund. The opportunity to participate in closed-end funds is only presented during an NFO. However, as Jayaraman points out, “closed-end funds don't make sense here as you may find it difficult to exit it at a later date.”

Various other drawbacks

NFOs lack a track record, and investors are unsure whether the fund house has the know-how to meet the unique difficulties brought on by a novel investing strategy for the specific fund.

Second, the NAV of a mutual fund is unaffected by supply and demand, unlike initial public offerings (IPOs). Therefore, when prices increase as a result of increased demand, one cannot expect to profit. Third, the lower AUM of NFOs results in greater expenses and a higher expense ratio. When a mutual fund issues an NFO, it must spend significantly on marketing, publicity, and distribution; as a result, these expenses could be included in the NAV.

Finally, investors need to be careful about the launch's timing. AMCs introduce new funds in order to diversify their offering or in response to market demand for a certain kind of fund.

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