NFOs trading below launch value: Consider exit if theme is too narrow

The recent market downturn has impacted mutual funds, especially recently launched equity new fund offers (NFOs). In recent years, fund houses have introduced several thematic and sector-focused schemes, attracting significant inflows. Many of these funds are now facing losses, with net asset values (NAVs) falling below the issue price. 

“Nearly 90 per cent of the NFOs launched in the past two quarters fall into sectoral/thematic or passive index fund category. The impact of the recent sell-off has been seen across themes like defence and public sector undertakings (PSUs) that attracted major inflows before the broad market correction. Factor-based funds like momentum have seen a drawdown of as much as 20 per cent in the past six months,” says Anil Rego, founder and chief executive officer, Right Horizons. 

Risks in NFOs 

NFOs come with inherent risks that investors should have considered before investing. Unlike established funds, they lack a track record. Smaller assets under management (AUM) can lead to higher expense ratios in the initial years, affecting returns. 

Many investors have also poured money into high-risk sectoral and thematic NFOs, which have concentrated exposure. Their mandates prevent fund managers from shifting to other sectors or themes if performance deteriorates. The performance of sectors and themes  tends to be cyclical. Investors who enter at the peak of the cycle risk face years of underperformance. 

 

Assess fund’s risk profile 

Investors should evaluate whether the NFO they invested in aligns with their portfolio and financial goals. “Investors should first understand the fund’s objective and style —growth, value, passive, or active — and whether it aligns with their risk tolerance and financial goals,” says Ravi Kumar TV, founder, Gaining Ground Investment. 

Risk appetite is another crucial factor. Small-cap funds, sectoral and thematic funds, and factor-based strategies like momentum funds involve greater risk. 

“Sectoral and thematic NFOs follow a narrow investment mandate, resulting in concentrated exposures. They require well-timed entry and exit strategies. Investors who lack the expertise, time, or effort to actively manage such investments should consider diversified options,” says Rego. 

Single-factor strategies also require precise timing. Market leadership rotates among factors—quality, value, momentum, etc. If investors hold single-factor funds, then they need to time their entry and exit, which many may not be capable of. They should either exit these single-factor funds or combine four-five factors in a portfolio so that one or the other performs at any given point. 

If holding a diversified fund 

Investors in diversified equity NFOs should assess their investment horizon. “Investors should have a minimum holding period of five to seven years for equity-oriented schemes,” says Rego. “For small-cap funds, an even longer horizon—at least 10 years — is advisable,” says Pankaj Mathpal, managing director, Optima Money Managers. If the investment horizon is sufficient, investors can consider investing in the chosen category. 

NFO or established fund? 

Investors must finally take a call on whether to remain in an NFO without a track record or shift to an established fund. Experts recommend choosing a fund with a proven history.  

“If a well-performing fund with a strong track record is available in the same category, why not prefer that?” says Mathpal.

The only reason to stay in an NFO is strong confidence in the fund manager’s ability to deliver results.