New Fund Offers: Opportunities And Challenges

Should you subscribe to New Fund Offers (NFOs)? While the buzz surrounding each NFO is tremendous and may tempt you to take the leap, it is important to make informed choices. The article weighs the pros and cons of investing in NFOs 

In recent years, the mutual fund industry in India has witnessed a proliferation of New Fund Offers (NFOs), signifying a remarkable surge in the introduction of these investment avenues. The statistics speak for themselves with the second quarter of FY24—July, August and September—seeing the launch of a total of 47 NFOs, collectively mobilising an impressive Rs 21,861 crore. A broader perspective reveals that year-till-date (YTD) 128 NFOs have made their debut, attracting a substantial Rs 41,787 crore in investments. It’s important to note that these numbers pertain exclusively to open-ended funds. 

NFOs often generate a great deal of excitement and attention. As a potential investor, you may have observed the buzz surrounding the launch of these funds. Webinars featuring fund managers discussing the new funds and their investment strategies have become commonplace. In addition, advertisements in newspapers and on television further contribute to the allure of NFOs. Given the marketing efforts and buzz surrounding them, it’s only natural to consider investing in an NFO. 

However, the pivotal question remains: Is investing in an NFO the right choice for you? To address this question comprehensively, we have prepared this article. In the following sections, we delve into the fundamental aspects of NFOs, exploring their advantages and disadvantages, and provide insights into the crucial factors to consider before making a decision. We go even further by offering an analysis of NFO performance relative to their peers. This comprehensive evaluation aims to provide you with the knowledge and insights needed to make well-informed investment decisions. 

Understanding NFOs will help you navigate the intricate part of mutual fund investments. We will explore its nuances guiding you through the decision-making process. Furthermore, we will venture into the realm of historical data and trends, considering the performance of NFOs over various timeframes. This historical perspective is instrumental in helping you comprehend the real-world implications of investing in NFOs. By examining past NFO launches and their outcomes, we aim to provide you with valuable insights into their potential risks and rewards. Ultimately, the decision to subscribe to an NFO should be a well-considered one, aligning with your financial goals and preferences, and ensuring a prudent approach to mutual fund investments. 

Understanding NFOs
An NFO serves as the vehicle through which asset management companies (AMCs) raise capital from investors. These funds are then used to acquire securities and construct portfolios, generating management fees for the AMC. When an AMC launches a new fund, it effectively opens the door for investors to participate. While the process may bear some resemblance to an Initial Public Offer (IPO), it is crucial to recognise that NFOs and IPOs are fundamentally distinct in their objectives. NFOs are primarily designed to secure funds from investors for the purpose of investment in a diverse range of securities, aligning with the fund’s stated objectives. 

In contrast, IPOs serve the purpose of raising capital for various corporate needs, such as acquisitions, debt repayment and working capital requirements, among others. Once the subscription period for an NFO concludes, the fund proceeds to accept fresh investments within a short timeframe, typically a matter of days. This practice applies particularly to openended funds. In contrast, close-ended funds limit investments solely to the NFO period, adhering to regulatory guidelines that stipulate an NFO’s duration should not exceed 15 days. This distinctive structure and regulatory framework set NFOs apart from IPOs. 

Deciphering the Dynamics of NFO Launch Trends 

As evident in the visual representation above, there was a remarkable surge in the number of NFOs launched during the exuberant year of 2007. Subsequently, the trend in new NFO launches exhibited a decline. However, a pivotal turning point occurred with the demonetisation event in November 2016, which sparked renewed momentum in NFO launches. This resurgence was so pronounced that it reached levels akin to those witnessed in the year 2007, demonstrating how investors are attracted towards NFOs when the market is at its peak. 

A noteworthy milestone in this journey was the outbreak of the corona virus pandemic. Despite the challenges posed by this global crisis, NFOs managed to mobilise Rs 145,902 crore in the combined years of 2020 and 2021. This remarkable achievement underlines the enduring enthusiasm among investors for NFOs when the equity market starts giving better returns. 

Advantages of Investing in an NFO
Investing in NFOs presents a range of benefits, although they are relatively limited in number. These advantages encompass:
1. Unique Themes - NFOs often provide the opportunity to invest in distinctive themes introduced by AMCs. For instance, the launch of the HDFC Defence Fund in May 2023, centred on the defence theme, exemplifies this. Carefully assessing and investing in such themes can contribute to the diversification of your investment portfolio.
2. Flexibility - In the case of close-ended NFOs, there exists a unique flexibility for fund managers to adapt to market conditions. Should a fund be introduced during a market peak, fund managers can manage a portion of the invested capital in cash, allowing them to make opportunistic investments at more favourable times. This flexibility serves to minimise drawdowns for investors. 

Disadvantages of Investing in an NFO
Conversely, there are several disadvantages associated with investing in NFOs, including:
1. Lack of Performance History: Since NFOs are novel offerings, they lack a historical performance track record, including portfolio holdings and net asset value (NAV) data. Investors are privy only to the broader strategy of the fund, leaving them uncertain about the specific components of the portfolio
2. Higher Expense Ratio: Investment in any mutual fund, whether new or established, incurs management fees. These fees are typically charged as a percentage of the portfolio and are deducted from the returns generated. Notably, NFOs with smaller assets under management (AUM) can levy higher expense ratios compared to funds with more substantial AUM, as per the regulations established by the Securities and Exchange Board of India (SEBI). 

NFOs Launch Timing
The timing of NFO launches is a critical factor to consider when evaluating these investment opportunities. AMCs introduce new funds for two primary reasons – to diversify and expand their product offerings or in response to market demand for specific fund categories. However, it is essential to recognise that the mere introduction of a new fund does not automatically signify an ideal opportunity for investment. This understanding is reinforced by the data depicted in the ‘Deciphering the Dynamics of NFO Launch Trends’ graph, which illustrates a trend where a significant number of NFOs tend to be launched during periods of market euphoria. 

For instance, the year 2007 witnessed an exuberant surge with the launch of around 124 NFOs, representing a staggering 170 per cent increase compared to the previous year i.e. 2006. This period of market euphoria was swiftly followed by the global financial crisis, emphasising the need for caution during such fervent times. A similar pattern emerged in 2018 when there was a remarkable uptick in the number of NFOs, registering a 187 per cent increase compared to 2017. Yet again, this wave of NFO introductions was followed by a subsequent market correction, with the broader market experiencing a decline of over 10 per cent. 

To illustrate further, let us consider the example of international funds. In 2019, this category delivered exceptional returns of 25.9 per cent, with only one NFO introduced during that year. However, in the following year, five new NFOs were launched. Remarkably, the strong performance of international funds persisted in 2020, generating double-digit returns of 19.04 per cent. Recognising this as an opportunity, a total of 18 NFOs in this category were launched in 2021, marking a historical high. Yet, in the subsequent year, 2022, international funds experienced a sharp decline, becoming one of the worstperforming categories with a negative return of 14.6 per cent. 

Evaluating NFO Performance across Timeframes To gain a comprehensive understanding of the real-world experience of investing in NFOs, we conducted a rigorous study. Our analysis focused on NFOs launched in the years 2007, 2013 and 2018. In this study, we systematically compared the performance of these NFOs with that of existing funds. It is important to note that for our analysis, we exclusively considered equity NFOs, excluding index funds and Exchange Traded Funds (ETFs). This approach enabled us to provide a focused assessment of NFO performance relative to existing funds, considering their track records and adaptability over time.


 Among the 24 funds launched in 2007, it is noteworthy that 75 per cent, 83 per cent and 54 per cent of these funds exhibited underperformance relative to existing funds over the respective one-year, three-year and five-year periods following their launch. While the degree of underperformance has shown a decline in the five-year post-launch period, it remains notably above the 50 per cent threshold.
 

In 2014, a notable contrast in dynamics emerges. The NFOs displayed a tendency to outperform existing funds, albeit with a caveat. Upon closer examination, this outperformance appears to be gradually diminishing. Furthermore, even over the five-year period, underperformance persists at approximately 50 per cent. 

This stands out as an exception from the usual pattern. In 2018, a significant number of NFOs outperformed existing funds, largely driven by thematic, pharmaceutical and Small-Cap funds. It's worth noting that pharmaceutical funds, which had previously struggled, rebounded during the pandemic, notably influencing NFO performance over the three-year and five-year periods. Additionally, NFOs benefited from maintaining cash reserves during challenging market conditions, contributing to this shift in performance. 

Conclusion
The world of NFOs is a dynamic one, offering both opportunities and challenges for investors. While NFOs can present unique themes and flexibility, they come with their share of disadvantages, including a lack of performance history and potentially higher expense ratios. The historical trends in NFO launches reveal a pattern of enthusiasm and increased activity during market euphoria, as exemplified by the surge in NFOs in 2007. However, this exuberance is often followed by market corrections, emphasising the importance of timing and due diligence when considering NFO investments. 

Our analysis of NFO performance over various timeframes demonstrates that outcomes vary based on the year of launch. NFOs launched in 2007 faced a higher likelihood of underperforming existing funds, especially in the short term. In contrast, NFOs from 2018 showcased a different trend, with many outperforming existing funds, particularly in thematic, pharmaceutical and small-cap categories. These historical insights underscore the significance of assessing each NFO on a case-by-case basis. Investors should carefully evaluate NFOs, considering their specific investment objectives, risk tolerance and market conditions. 

Moreover, due to the absence of historical data, an NFO’s success largely relies on factors such as the fund manager’s expertise and the AMC’s reputation. In the ever-evolving landscape of NFOs, making informed investment decisions becomes paramount. It is advisable for investors to exercise prudence, seek professional advice, and stay vigilant in the face of the ever-changing financial market dynamics. Ultimately, the decision to subscribe to an NFO should align with one’s financial goals and preferences, ensuring a prudent and well-informed choice in the world of mutual fund investments.