IPO vs NFO: differences and what to check before investing

Say a mutual fund ad on your phone offers units at Rs 10. The same week, you check a fund you already own and its price is Rs 280. It feels like the new one is the better deal. Lots of people think so. It is one of the most common mix ups in mutual funds, and it gets worse because NFOs and IPOs often come up together in the news.

They sound alike. They work very differently. Here is how each one works, where the comparison falls apart, and what to look at before you put money into a new fund.

• What is an IPO?
• What is an NFO?
• IPO vs NFO: side by side
• Why Rs 10 in an NFO is not cheap
• What to check before you invest in an NFO
• Key takeaways
• Frequently asked questions
• Final word

What is an IPO?

IPO stands for Initial Public Offering. It is the first time a company sells its shares to the public.

Before it can do this, the company has to send a detailed document to SEBI, the market regulator. This document is called the draft offer document. It covers the company's past three years of numbers, who runs it, any court cases against it, and the main risks of the business. SEBI reviews it, and then the company opens a window of a few days when people can apply for shares.

The company gives a price range. Investors apply within that range, and the final price depends on how much demand there is. If far more people apply than there are shares, investors are picked by lucky draw. Many people who apply get nothing.

You do not have pay upfront when you apply. The money is blocked in your bank account. If you don't get shares, the hold is removed and the money is yours to use again, usually within a few days.

After that, the shares start trading on NSE or BSE. From then on, the price goes up or down with buying and selling on the exchange. The company keeps the money it raised and uses it for what it said in its offer document, such as growing the business or paying off loans.

If you apply for an IPO, at least read the risk section and the money summary in the offer document first.

What is an NFO?

NFO stands for New Fund Offer. It is how a mutual fund company launches a brand new fund.

The fund company writes a document that explains the fund's rules. It is called the Scheme Information Document, or SID. SEBI checks it. Then the fund opens for a short period, usually up to 15 days, and anyone can buy units at Rs 10 each.

When that period ends, the fund manager takes all the money collected and starts buying shares, bonds, or whatever the fund is allowed to buy. From then on, the fund's price per unit (called NAV) changes every working day based on what those investments are worth. In an open ended fund, which is the most common type, you can buy or sell units on any working day after the NFO ends.

So far it sounds a lot like an IPO. There's a short window, a fixed entry price and SEBI approval, and new money goes into something new. That is where the likeness ends.

In an IPO you buy a piece of one company. If that company does badly, your money suffers. In an NFO you buy a small share of a basket that will hold many different investments. What you own is a different kind of thing, and so are the risks.

IPO vs NFO: side by side

Why Rs 10 in an NFO is not cheap

Take the fund priced at Rs 280. That number means each unit is backed by Rs 280 worth of real investments at today's market prices. You pay Rs 280 and you get Rs 280 worth of stuff.

Now take the NFO at Rs 10. At that stage the fund hasn't bought anything yet. Rs 10 is just the starting number. Once the money is invested, the unit price follows whatever the fund bought. If the manager buys investments that then fall, the price will drop below Rs 10, and it can happen in a few months.

It helps to think of it like this. Rs 1,000 buys you 100 units at Rs 10 or about 3.5 units at Rs 280. Either way you have Rs 1,000 invested. If both funds go up 10%, you have Rs 1,100 in both cases. The number of units makes no difference to your gain.

A share is different. When a stock falls from Rs 500 to Rs 10, people sometimes feel it is cheap. A fund's unit price doesn't work that way, so don't read a low starting price as a bargain.

What actually decides whether an NFO is worth it: what the fund is allowed to invest in, how good the fund house has been with its other funds, and what prices the manager ends up paying for those investments. The Rs 10 tells you none of this.

What to check before you invest in an NFO

Read the SID first. The brochure and the ads are there to get you to invest. The SID is the actual rulebook. It tells you what the fund can buy, which index it will be compared against, the most it can charge you each year, and the fee for leaving early (called exit load). You can find it on the fund company's website and on amfiindia.com.

Check if an older fund already does the same job. This is the most useful question you can ask. If the new fund is, say, a midcap fund, there are already several mid cap funds that have been around for seven years or more. You can see how they did in bad years like 2020 and 2022. With a new fund you can't see that. Past returns don't promise future returns, but they are real data. A new fund has nothing to show yet.

Look at the fund company's other funds. Have their existing equity funds kept up with their comparison index over several years, including rough patches? If yes, that counts for something. If their current funds have lagged for years, a new fund from them deserves more doubt, however good the ad looks.

Find the maximum yearly charge. In the early stage, the cost figure shown to you may only be a rough guide. The SID lists the highest yearly charge the fund is allowed to take. Compare that number with what similar older funds actually charge today.

For theme or sector funds, check the exit load period. Some of these funds charge a fee if you leave within a longer period than usual. If the theme doesn't work out, that fee makes it costly to move your money.

Key takeaways

IPOs and NFOs both have a short window to invest and both are overseen by SEBI. Otherwise they are different products. An IPO sells you part of one company. An NFO sells you units in a fund that will then buy many investments.

The Rs 10 price means nothing on its own. What matters is what the fund buys with your money and at what prices.

Before you buy any NFO, see if an older fund in the same category gives you the same thing with a track record you can check. In most cases one does.

Spend twenty minutes on the SID. It answers the questions the ads leave out.

Mutual Fund investments are subject to market risks. Please read all scheme-related documents carefully before investing. This blog is for educational and informational purposes only and does not constitute investment advice or a recommendation to invest in any IPO or NFO. Readers are advised to consult a SEBI-registered investment advisor before making any investment decision. Investa Finserve is an AMFI-registered Mutual Fund Distributor. ARN: 138207.