How is the amount collected in a new fund offer invested?

So far this year, the Rs 26.85 trillion Indian mutual funds (MF) industry has rolled out 93 new fund offers (NFO) across equity and debt categories. But how does a new fund deploy the inflow? Does it invest everything the next day after your NFO period closes or does it take a few months to build its complete portfolio? Here is how an NFO works.

Earlier, fund houses used to roll out NFOs regularly. After the announcement of the scheme categorization rules in October 2018 by the Securities & Exchange Board of India (SEBI), fund houses cannot go overboard with new fund offers.

The rules allow only one product in a category. There are 36 categories that SEBI has notified. However, in some categories such as thematic and exchange traded funds, asset management companies (AMCs) can roll out multiple schemes, provided they are different from one another.

How long is an NFO open?

As per regulations, an NFO can be kept open for a maximum 15 days. Typically, equity funds’ NFOs are open for 15 days. Debt funds, especially fixed maturity plans (FMP) and those investing in very short term fixed income options such as liquid schemes are kept open for a very short period of time, for just about three days or so.

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Units are allotted within five days after the NFO closes. If you don’t get allotment, say, because of incomplete know-your-client (KYC) norms or mistakes in application forms, your fund house refunds the application money.

Every NFO must comply with the 20-25 rule. This rule mandates that there be at least 20 investors in the scheme and no single investor account for 25 per cent or more of the money invested in the fund. In fact your scheme has to stick to this 20-25 rule at all times.

Where does your NFO invest?

Because the NFO usually generates substantial funds, it doesn’t invest it all in one go. The fund has about six months to invest the amount. There are situations when the stocks identified by the fund manager may be illiquid or the fund manager may expect a correction in the prices of some stocks. That’s also why typically an equity NFO invests significantly in arbitrage opportunities initially to ensure the 65 percent threshold investments in equities, to avail equity taxation benefits. “Portfolio disclosures by the fund house in the initial months need to be carefully analysed to check the progress in portfolio construction in line with the strategy or theme discussed while marketing NFO,” says Amol Joshi, founder of Plan Rupee Investment Services.

Index funds and FMPs deploy their funds quickly. “In the last one year, some fund houses transferred bonds held in open-ended schemes to FMPs, which changed the risk-reward for FMP investors. That made investors go slow on FMPs,” says Saji Pulikan, co-founder and CEO of LitMfin.com. Besides, since an FMP buys and holds its underlying instruments till maturity, it’s crucial that it deploys the NFO proceeds at the earliest and at the yields prevailing at the launch time due to which it got rolled out in the first place.

Should you invest in an NFO?

In general, it is advisable to avoid NFOs, unless it offers you a theme or a strategy that is not available elsewhere in the MF industry. Also, open-ended schemes usually work better than closed-end schemes as the former gives you the flexibility to exit at any time you want.

But if you must invest in an NFO, you can either transfer money from your bank account using internet transfer or write a cheque. Of as Saugata Chatterjee, Co-Chief Business Officer, Nippon India Mutual Fund says, “Investors can park their money in an overnight or liquid fund and switch to a new fund offer during the closure of the NFO.” Remember, while switching out investments from liquid funds they attract exit loads for the first six days from the date of allotment of units.