NFO
A call for investors to invest money into a new fund
What is an NFO?
An NFO (new fund offer) is a call for investors made by an asset management company (AMC) to invest money into a new fund. An AMC is an enterprise that collects money from different clients and places the funds into different investment opportunities, like equity stocks and real estate.
AMCs generally fix a particular amount of money to be invested in a specific security and divide the entire capital into units worth smaller denominations. The price per unit of an NFO, also known as Net Asset Value (NAV), can range between a few dollars to several hundred dollars.
Summary
- A new fund offer (NFO) is a call for investors to invest money into a new fund.
- An NFO is similar to Initial Public Offering (IPO) in the sense that investors’ money is used to purchase securities.
- NFOs can be issued for a limited number of units (closed-ended funds) or can be available for purchase and redemption on a continuous basis.
NFO vs. IPO
An Initial Public Offering (IPO) is the call to raise capital for a new company or to raise additional capital for an existing company. It is similar to a new fund offer in the sense that a company is collecting a large sum of money from different investors. However, it is different from NFO in the following ways:
1. Price of Issue
The NAV of an NFO is fixed on the basis of the price of the security in which the collected funds will be invested. On the other hand, the price of an IPO is set by the issuing company. It can be fixed above or below the face value of the stock, depending on the preferences of the issuer.
2. Type of investment
In an IPO, the investor invests his money directly into the issuing company. In an NFO, however, investors give their money to the AMC, which, in turn, invests it into different kinds of securities, including but not restricted to stocks.
3. Trading
Shares purchased through an IPO can be traded on a stock exchange platform. On the other hand, some kinds of NFO cannot be traded like stocks. They can only be purchased at one time and redeemed when required.
Practical Example
Consider the following example. An AMC launches an NFO for a closed-ended Fund X for one year. It sets the NAV at $100 per unit, and there are 100 units in total, fixing the total capital at $10,000. The annual rate of return is 15%.
Person A decides to buy 10 units of Fund X on January 1, the day of its launch. Due to a bullish phase in the market, the price of the tradeable fund rises to $120 per unit on May 31, and A sells all of their units in the stock market.
On October 1, A again buys 10 units of X at $110 and retains them until the end of the year, when they are redeemed. The company pays $100 for each unit of the fund and provides $15 per unit as return.
The profit made by A in cash is $250 (-1,000+1,200-1,100+1,150).
Units of the fund can be redeemed only at the end of the specified period, but the same can be traded on a stock exchange. However, the NAV per unit does not change.
Now, if Fund X was an open-ended fund with the same NAV at $100 per unit and an annual rate of return at 15%, but no limit on the total number of units or total capital, it could’ve been redeemed at any time. Person A buys 10 units of X on January 1, thereby giving the company $1,000 to invest.
On March 31, A redeems 6 units. Assume A is the only holder of the fund in the market. Therefore, the size of the fund now falls to $400 ($100 x 4). The company wants to maintain the size of the fund at $1,000, so it invests the remaining $600 on its own.
On October 1, A decides to purchase four units of X. Now, the company sets the NAV at $150 per unit ($600/4). On December 31, A redeems all eight units of X for a total of $1,000.
The units of the fund can be redeemed at any time, but they cannot be traded. Every time units are purchased or sold by investors, the size of the fund changes and the NAV per unit varies accordingly.
The profit made by Person A in cash is $120 (-1,000 + 637.50 – 600 + 1,082.50).
Is It Safe to Invest in an NFO?
It is very important to run a background check on the AMC that is offering the NFO and the security in which the fund will be invested. An NFO entails the added risk of not knowing what the portfolio will be like or how much return the new securities are likely to offer.
Although funds are a relatively safer investment option than stocks, the following points must be kept in mind while investing in the securities.
1. Track record of AMC
It is always better to invest in the funds of an existing AMC. Investors can analyze past track records in order to estimate the worth of the AMC and judge the profitability of its investments.
2. Lower NAV does not necessarily mean better investment
Investors tend to invest in closed-ended funds since they achieve lower NAVs than open-ended ones. However, open-ended funds are existing schemes with a track record that can be evaluated and are, therefore, less risky.
3. Invest according to personal requirements
NFOs can be launched for funds that invest in different kinds of securities. An investor with no previous experience should invest in an NFO that will invest in a portfolio of various securities, such as stocks of companies from different industries.
On the other hand, a seasoned investor looking to add a specific kind of security to their portfolio, say, stocks of pharmaceutical companies should invest in an NFO for the same.
Related Readings
CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:
