In an Initial Public Offer (IPO), private companies offer their shares to the public. Similarly, a mutual fund also allows the public a chance to invest when it initiates a fund. In other words, investors can invest in the initial pool of money when a new fund gets launched, called a New Fund Offer (NFO).
So what are the similarities between IPO and NFO? Are there aspects to know beyond that IPO invests in equity and NFO in mutual funds? To help the decision-making process, we will evaluate IPO vs NFO – which is better for investors?
More about the Initial Public Offer (IPO)
IPOs are an exit route for existing shareholders allowing them to unlock the initial investment, often at a premium. At the time of an IPO, there can be (1) a fresh issue of equity shares, (2) an offer of existing shares (aka Offer For Sale) by the current shareholders, or (3) a combination of both.
Primarily, there are three types of offers:
New offer where a company raises capital for the first time. The IPO proceeds act as a source to inject money into the business.
Offer for sale (OFS) is when the promotors, anchor investors, or both sell their shareholding via an IPO. In other words, an OFS does not require any fresh equity of shares. Therefore, only the shareholding pattern changes as a result of the IPO.
Follow-on offers are the ones where an already listed company issues stocks. The follow-on offers can be dilutive or non-dilutive. For instance, when a company gives new equity shares, the Earnings Per Share (EPS) reduces, meaning the offer is dilutive. Alternatively, a company can offer already existing shares of the company, which makes it non-dilutive.
What is an NFO
Like IPO, when the Asset Management Company (AMC) forms a fund and provides the public with an opportunity to invest, it is called New Fund Offer (NFO). In other words, the AMC announces a mutual fund with defined scope and objective and invites the public to invest.
NFOs are open for a particular time, and usually, the units are available at a minimalistic cost per unit. After that, investors can purchase the mutual fund units at the existing Net Asset Value (NAV) from the AMC website or through an intermediary.
IPO vs NFO – a comparison
|Initial Public Offer (IPO)
|New Fund Offer (NFO)
|A mutual fund house
|Decided based on the fundamentals of the company, often at a premium compared to the face value of the shares
|Usually offered at Rs 10 per unit (or less) to cover marketing and administrative costs incurred during the launch of NFO
|Required to get the credit of allotted shares
|Investors get classified as Retail, HNI and Institutional, and there are separate quotas for each
|All investors are the same. In other words, there is no distinction
|Shares get listed on stock exchanges
|Investment is possible through the AMC website or third-party intermediaries
|Directly linked to the performance of a specific company
|Aggregate performance of a bunch of stocks, bonds, etc.
|Profit on the sale of shares is taxable, subject to exemption limits prescribed for long-term capital gains under the Income Tax Act
|Specified investments in Equity Linked Savings Scheme (ELSS) are available as a deduction from taxable income. In addition, same taxability rules apply for profit on the sale of mutual funds as for shares
|The investor buys shares of a specific company. Therefore, understanding metrics like P/E, P/BV, etc., is essential
|The investor contributes to the pool of the money, i.e., Asset Under Management (AUM). In addition, the mutual fund manages the investment of AUM, and investor preference is not possible
Usage of funds
|Company offering shares use the fund for its stated purposes (business expansion, marketing, repayment of the debt, etc.)
|Funds are collected to further invest in capital markets
|Medium-High. Company-specific and market risk both co-exist
|Low-Medium. Investment in any one company is minimal, and hence the company-specific risk is low. Further, mutual funds often invest into multiple assets classes, and thus the risk is split too thin, thereby minimizing the same
The timing of the market is relevant for both IPO and NFO. However, it affects both differently. For instance, suppose the market sentiment is bearish. In that case, IPOs may see companies listing at a discounted value and loss of capital for investors. On the other hand, a mutual fund can take advantage of low prices and invest NFO money into the capital market (mainly equities) at lower prices.
Above all, effective utilization of IPO funds by the company is critical. The most effective utilization will increase the share price that will eventually lead to capital appreciation for investors.
Further, in the case of an IPO, past financial performance, promoter pedigree, risk and opportunities, peer performance is available in the prospectus. On the other hand, the decision to invest in NFO is based mainly on the fund manager’s past performance. Therefore, a fund managers role becomes exceptionally critical here.
The mutual fund houses often provide backtesting results to aid investment decisions. In other words, a calculation of fund performance if it existed from the past. Of course, there is no guarantee that history would repeat, but that calculation does provide an indication.
In conclusion, IPO vs NFO – which is better for investors?
An IPO is an offer made by the company to investors to invest in the company’s shares. On the other hand, NFO is the initial offer to buy units of the AUM of a mutual fund launched by an Asset Management Company.
Investment into equity is direct exposure to the future of the company. Therefore, equity is considered a risky asset. Also, equity investment demands a certain degree of understanding and research about the company.
In the case of investment into a mutual fund, professional money managers make investment decisions. They invest money based on the objectives of the mutual fund. In other words, retail investors do not participate in the investment-related decision-making process.
Further, IPO and NFOs are subject to market risks and external factors (regulatory environment, interest rate environment, etc.), though the impact may vary.
In conclusion, IPO is a decent investment opportunity for investors who understand companies and have a high-risk appetite. On the other hand, investors who would like to participate in capital markets but not directly and have a low-risk tolerance can choose NFOs.
Above all, IPOs is, in a true sense, an investment. The money gets directly invested in a business, and investors become owners (equity). NFOs, on the other hand, are a passive way to participate in capital markets with minimal exposure to any individual company. Therefore, NFOs are more likely a form of means of investment.
About the author
The author is a senior finance professional with over fifteen years of work experience in corporate finance. He has an affinity for matters relating to personal finance and investment management. Through his writing, the author wants to share his knowledge and understanding of the subject.
The author has used his knowledge, experience, and understanding of the subject and has exercised extreme caution to avoid possible mistakes. However, the author does not take any responsibility for any error that exists.
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