How NFOs Can Add Diversification to Your Portfolio

NFOs are drawing investors’ attention as an investment avenue in the realm of investment instruments. The NFO is the one-time subscription period available to investors when a mutual fund house introduces any new scheme.

That becomes an avenue to subscribe to the units of a mutual fund scheme at its NAV, which normally is kept at ₹ 10 during the initial offering of such scheme.

The article throws more light on how NFOs can play an important role in portfolio diversification in the Indian financial market along with key concepts like NAV and mid-cap mutual funds.

What’s so special about NFOs?

NFOs are those which are new in the market, unlike mutual fund schemes already on offer, and almost always introduce new strategies or funds that are usually niche sector-based. The schemes target those particular investment needs of investors which are not met either fully or partially by already available schemes. Such NFOs may target equity, debt, hybrid funds, or sectoral themes.

The major feature of the NFOs is that these funds have an introductory NAV of ₹ 10 during the initial offering period. It is this initial simplicity that invites investors who may want to explore fresh avenues unencumbered by historical fund performance since the NFOs start from a clean slate.

Diversification Potential with NFOs

Sectoral Diversification

As a rule, NFOs focus on niche sectors. If a mid-cap mutual fund NFO were available, it would give investors the opportunity to take advantage of the opportunities that are starting to emerge in industries which may not be well-represented in their portfolio, by targeting only mid-cap companies showing high growth potential.

Mid-cap stocks fall in that sweet spot between high-risk small-cap stocks and the relative stability of large-cap stocks. An investor can thus add some variety to the equity segment of his portfolio by investing in mid-cap mutual funds through NFOs.

For example:

A well-established mid-cap mutual fund can trade in the range of ₹ 50 – ₹ 150 NAV, depending on the market and performance of the fund.
A typical mid-cap-oriented NFO starts off with a per-unit NAV of ₹ 10. If the performance of its portfolio is steady, then, over time, the NAV can appreciate considerably.
Now, let’s assume that an NFO is growing its NAV at 12% every year. You start investing ₹1,00,000 in the fund. After one year, the NAV has grown to ₹11.2. At compounded annual growth, in five years, your investment can grow:
Formula: Future Value = Investment × (1 + Annual Growth Rate)^No. of Years
Calculation: ₹1,00,000 × (1 + 0.12)5 = ₹1,76,234

Breadth in Asset Allocation

NFOs often introduce hybrid or ‘thematic’ schemes that combine equity, debt, and other asset classes in one portfolio. This proves to be of immense use for the balanced investor. Example:

Hybrid NFOs can invest 60% in equity that also includes mid-cap mutual funds, while the remaining 40% is invested in debt securities.
This combination reduces equity risk and offers periodic returns through the debt instruments. Assume you invest ₹ 50,000 in equity and ₹ 50,000 in debt through this hybrid NFO, and consider an annual equity return of 12% with a debt return of 6%. Then, after 5 years, your portfolio value could be:
The FV of Equity = ₹50,000 × (1 + 0.12)5 = ₹88,117
FV of debt = ₹ 50,000 × (1 + 0.06)5 = ₹ 67,066
Total Portfolio Value: ₹88,117 + ₹67,066 = ₹1,55,183

Monitoring of NAV and Risk Management

Investors also consider the tracking of NAV important in terms of the growth and profitability of an investment. It simply means the mutual fund unit price at any single time, computed as:

Formula: NAV = (Total Assets – Liabilities) / Total Units Outstanding

For example, assume an NFO collects ₹ 50 crore and allots 5 crore units to its subscribers and has negligible liabilities. The NAV would be ₹ 10 during the subscription period (₹ 50 crore / 5 crore units). As the fund earns returns and the corpus grows, so does the NAV, reflecting appreciation in the portfolio.

However, investment through NFOs holds some amount of uncertainty due to the fact that no past record exists with which to analyze the performance of such funds. Hence, investors need to measure the risk and position their investments accordingly in relation to their overall financial objectives.

Why Mid-Cap Mutual Fund NFOs Matter for Diversification

Mid cap mutual funds fall into a special niche regarding the need for portfolio balance. These mid cap mutual funds invest in companies which come out of the top 100 but within the top 250 in market capitalization. They promise a higher growth rate than large-cap stocks, with the risks being higher too.

Consider an investor who has large-cap, small-cap, and debt funds in his portfolio already. He fills the gap by adding the moderately volatile but growth-oriented equity component of mid-cap mutual funds to his portfolio through an NFO participation. Thus, he spreads the risks and rewards across market segments.

Summary

New Fund Offers are new mutual fund schemes launched by the fund houses and offered for subscription at an initial Net Asset Value of ₹ 10. They offer an entry into new investment avenues, often targeting new sectors or thematic strategies that could be on offer from mid-cap mutual funds. NFOs allow diversification of a portfolio by exposing investors to some unexplored markets and different mixes of assets. For example, an investment in mid-cap mutual funds via NFOs adds balanced risk and reward to equity investments. Furthermore, hybrid schemes in the NFO meld equities, debts, and other classes of assets into one portfolio for a diversified stance. Since no past performance record is present from which to judge, uncertainty surrounds investing in an NFO. Careful monitoring of NAV and market conditions becomes pivotal to assure profitability in such cases. As a tool of diversification, NFOs hold immense potential but call for thoughtful risk assessment.

Disclaimer

NFOs, mid-cap mutual funds, and other investments involve market risks. The investor has to do personal research or due diligence, carefully consider the pros and cons before making the choice of an investment or starting trading in the Indian financial market. Be sure to invest based on your financial goals and risk tolerance. Past performance is not indicative of future performance.

💬 FAQs

What is an NFO in mutual funds?

An NFO (New Fund Offer) is the initial subscription period when a new mutual fund scheme is launched, allowing investors to buy units at a base price before it opens for regular trading.

How can NFOs help in portfolio diversification?

NFOs often invest in new sectors, themes, or strategies, providing investors an opportunity to diversify beyond existing mutual fund categories.

Are NFOs safe for beginners?

NFOs can be beneficial, but they come with limited performance history. Investors should research the fund house, objectives, and risk factors before investing.