Tips For Reading NFO Documents

With a lot of NFOs getting launched it becomes difficult for an investor to analyse each of them in depth. In fact, each NFO comes with a 100-page document on an average. Reading it line by line is indeed a tough task. The article therefore highlights the sections that you should focus on

We have been witnessing a flood of New Fund Offers (NFOs). In fact, there were almost 88 NFOs that were launched in FY 2020-21, about 155 per cent higher than the historical average and 75 per cent higher than the 10-year average launch per year. This can very well be attributed to the rally in the equity market, which was followed by a 40 per cent fall in the equity market in March 2020 amid pandemic-induced lockdown. With a lot of NFOs getting launched it becomes difficult for an investor to analyse each of them in depth. In fact, each NFO comes with a 100-page document on an average. Reading it line by line is indeed a tough task.

Therefore, investors tend to choose NFOs that mutual fund intermediaries suggest to them. However, there is always a conflict of interest involved between the intermediary and the investor. Hence, it makes more sense to do your own research before subscribing to any NFO. This article will make things simpler for you through our explanation of how to read an NFO document. Certainly, you don’t need to read the whole document word for word. You just need to look at certain aspects that would matter a lot to you as an investor. Therefore, stay tuned with us to the end to become an expert in reading an NFO document like a professional!

The NFO Document
A lot of people confuse an NFO document with that of an Initial Public Offer (IPO) prospectus. Though they sound similar, they are quite different from each other. An IPO is a document that comprises details such as offer price, funds the company proposes to raise, objective of raising the funds, how it is going to deploy those funds, what its financials look like, etc. However, in an NFO a fund house provides information such as what is this fund all about, what would be the investment strategy, who would be managing the fund, which index it will be benchmarked against, what is its objective, what would be its asset allocation, etc.

So, do not get confused between NFO and IPO. The NFO document usually comprises the Scheme Information Document (SID) and Statement of Additional Information (SAI).The SID provides access to important information of the scheme such as investment objective, asset allocation pattern, risk involved, investment strategy, fund manager, benchmark index, fees and expenses, etc. On the other hand, SAI carries all the statutory information of the asset management company (AMC).

Reading a NFO Document
As SID is the document which contains important information regarding the fund, it makes sense to go through it first. Listed below are the contents that you should look out for in an SID.

Investment Objective : This elucidates the intent behind the launch of a scheme and how it will achieve it. For instance, if the fund is an equity-oriented fund, you will find the term ‘capital appreciation’. In order to understand it in a better way, let us take the example of the investment objective of a flexi-cap fund: ‘The investment objective of the scheme is to generate capital appreciation from a portfolio, predominantly invested in equity and equity-related instruments without any restrictions on market capitalisation.’

Asset Allocation : This section of the document shows how the scheme would be allocating the assets among relevant asset classes such as equity, debt, gold, REITs, etc. It usually gives the range of allocation from the maximum and minimum exposures from various asset classes. This is one of the most important sections for investors as from here they can understand whether or not the scheme suits their risk appetite. In order to make it simple for investors, it also provides the risk profile of individual asset classes. As you all might know, equity is already considered as a high-risk asset class. Therefore, here there won’t be a problem for investors. The real problem is with the debt funds. This is because debt funds can have a range of risk profiles ranging from high to low. A credit risk fund would have a high risk profile for its asset allocation whereas a corporate bond fund might have a low risk profile.

Investment Strategy : This is also one of the most crucial sections that an investor should have a look at. In this section the document will provide the rationale behind the securities’ selection. Along with its strategy on selecting securities it will also reveal the style of investing i.e. whether it will have value, growth or a blend of value and growth investing options. Not just that but it will also show – in case of an equity fund – whether the security selection is based on top-down or bottom-up approach. Moreover, the section will tell you about the investment process and systems. This section will help you understand what kind of securities the scheme is likely to include in the portfolio. A fund following value investing strategy would avoid a stock with higher PE ratios or other valuation ratios.

Benchmark: The benchmark of the scheme gives you a fair idea about the likely constituents of the fund’s portfolio. However, there are high chances for the fund to have constituents and weights that are different from that of the chosen benchmark. This is not applicable for index funds and exchange traded funds (ETF) that track the particular index. However, benchmark can certainly give you a rough idea about the returns and risk that you can expect from the fund.

Risk Factors: Again, this section of the SID is something that most investors skip reading. However, we would urge investors not to ignore this as it will help you understand what are the risks that the fund is undertaking or likely to undertake. Take the case of liquid funds. Typically, liquid funds are considered comparatively safer investments as they invest in fixed income securities with Macaulay duration of less than 90 days, which means lower volatility. However, funds like Franklin India Liquid Fund, which takes credit risk, provides superior returns. Reading through the risk factors would have made you known these factors early.

Fund Manager: In this section you will find information about the fund manager who is going to manage the scheme for its unit holders. Here you would find elaborate details about the fund manager in terms of his qualification and experience, the duration since when he is managing funds for the AMC, where he previously worked and in what position, and what other funds does he manage for the AMC. As the fund manager is the captain of the fund, it is important to understand who is going to manage the fund. Moreover, you can also check the performance of the funds that he already manages to get a fair idea about his fund management style and the securities that he picks.

Miscellaneous: Apart from the above things, there are also few other things such as fees and expenses, minimum amount required for the systematic investment plan (SIP) and lump sum, details about the trustee and custodian, when the fund will close and then again re-open for subscription, etc. These are the basic yet useful information tips for investors.

Conclusion
Reading a long document is quite a tiring process. Hence, as an investor you need to find a way to read things that are important for you. Therefore, we have listed above the items that you should look for in a NFO document. With this you would be able to make better investment decisions and not fall prey to any grandiose statements. All the above listed factors would indeed help you not just to understand the fund but also be able to gauge the credibility of the fund house.