Saturday, July 26, 2014

What is the NAV of a mutual fund? Why is it important? Why should I buy a fund with high NAV?

Translation of my article published in Mid-day Gujarati on 26th July, 2014

What is the NAV of a mutual fund? Why is it important? Why should I buy a fund with high NAV?
One encounters such questions regularly. It is important that such questions are answered for a better clarity. In the absence of proper understanding of a basic concept like NAV of a mutual fund, it is not possible for someone to take an informed decision.
NAV or the “Net Asset Value” is the realizable value of the mutual fund. A mutual fund is a vehicle that invests in various investment avenues. These investments may fetch some price if sold in the market. This value – current market price of the investments held by the fund – plus receivables less any payments that are pending from the fund, add up to the NAV of the fund. This total amount divided by the number of units of the scheme gives NAV per unit.
NAV has no meaning if taken in isolation. However, the NAV multiplied by the number of units in an investor’s account gives the current value of the investment.
In an open-ended fund, there would be some investors once it has been opened for public subscription on a regular basis. Out of these investors, some may wish to exit the fund for various reasons, while at the same time; some may want to buy units of the fund. How does one determine a fair price to all these?
That is where the NAV comes into picture. Let us say, the NAV of a fund is Rs. 25. However, for some reasons, the fund company decides to allow investors to transact at Rs. 15 per unit (This is not allowed under SEBI regulations. We are using this illustration only to explain a concept). In such a case, the buyers get the units at a steep discount, whereas the sellers lose. On the other hand, if the fund company decided the transaction price to be Rs. 35, the buyers would lose out and the sellers would gain.
Any transaction happening at a price that is not linked to the NAV would be unfair to either the buyers or the sellers or the long-term investors not transacting at a particular time.
Offering such a mechanism is important in case of a mutual fund considering that the ownership of the fund rests with the unitholders and not the company that manages the fund.
Often people stay away from a fund since the NAV is high. One has seen investors taking investment decisions based on the NAV of a fund. However, the NAV per unit is nothing but the total value of the entire fund divided by the number of units outstanding.
The following cases would help understand why NAV may not matter:
1.     Two identical schemes Fund A and Fund B both have total assets worth Rs. 100 cr each. Fund A has 1 crore outstanding units, whereas Fund B has 2 crore outstanding units. In this case the NAVs of Fund A and Fund B would be Rs. 100 and Rs. 50, respectively. Considering the Fund B to be better simply on this parameter is like that gentleman who went to a pizza shop. When the waiter asked him if he wanted to cut the pizza in six pieces or eight, this gentleman replied, “Cut it into six. I am not very hungry. I would not be able to eat eight.”
2.     A mutual fund scheme Fund D was launched with NAV of Rs. 10 when the NAV of an existing Fund C was Rs. 25. Assuming both having the same growth rate, after some time, Fund C had NAV of Rs. 50, whereas NAV of Fund D was Rs. 20. This only suggests that since the launch of Fund D, both the funds performed in exactly the same way. Still, due to longevity, Fund C’s NAV happens to be higher.
3.     Let us say Fund E and Fund F were launched at the same time with NAV of Rs. 10 each. After a year, Fund E’s NAV stood at Rs. 11, whereas that of Fund F was Rs. 13. In this case, Fund F’s NAV is higher on account of better performance.
Understanding the NAV is critical starting point for any mutual fund investor.
Happy investing!
Amit Trivedi
The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.

Tuesday, July 15, 2014

Making money in equity markets - my article

A recent post on Facebook caught my attention. It talked about the performance of certain diversified equity funds from the year 2003 to now. Instead of talking about specific schemes (which suffer from selection biases) referred in the post, we looked at the performance of an index, Nifty TRI. Nifty TRI or the Total Return Index captures the total return in form of capital appreciation as well as dividends. ...

Read more ...

Saturday, July 12, 2014

Jewellery Purchase scheme or disguised Fixed Deposits

A very interesting item caught my attention in today's Times of India, Mumbai edition. There is an advertisement fro Tanishq - a Tata Group company. The ad is not about launch of a new scheme, but that for the closure of one. This happened due to the introduction of the Companies Act, 2013.

Under the new Companies Act, there is an amendment in the Companies (Deposit Acceptance) Rules. Under these rules, the definition of deposits is widened to cover even advance payment systems.

Tanishq ran very successful jewellery purchase schemes under the names of "Golden Harvest" and "Swarna Nidhi". Both were highlighted as schemes facilitating the purchase from small savers. These schemes allowed people to deposit small sums of money each month for a certain period and then at the end of a specified period, buy jewellery from Tanishq out of the money so accumulated. In a sense, this was a very nice facility for people who can save small amounts. It was also good for the company since it allowed them low-cost float for the period of deposit. It was definitely far superior for the company than offering credit (EMI schemes) to the jewellery buyers.

What was missing, then? - The customer protection was missing. Many investors (I have replaced the word buyer with investors) entered such schemes without understanding what they were doing.

Before we move ahead, let me add a clarification here. The discussion from now on is not about the credentials of Tanishq. My respect for the group has only gone up with this advertisement. No other entity would take such a step as to put an advertisement in a leading daily related to a matter unnoticed by most and can have major impact on the company's financials, cashflow and business. 

Let us understand two separate purchase mechanisms:

  1. When a buyer pays advance to buy the item later: making payment now with a promise of delivery in future
  2. When a buyer buys on credit: getting delivery of the goods now, but paying later
In the second case, the seller would ask for various documents to verify the financial ability of the buyer to fulfil his (or her) side of the commitment. Only then would the goods would be delivered.

However, in the first case, the buyer starts making payment on "trust" without even having the choice to see the financial strength of the counter-party. Trusting someone is not bad, but it is important that it should be a choice and not the only option. 

Now by bringing all such mechanisms where the term of the contract is more than a year - or the time between the first payment and the delivery of goods is more than 365 days, this would be construed as a deposit.

There are some superb measures with respect to the safety of the depositors - some old and some added now:
  • Deposit trustee - appointment of an independent trustee is a must now
  • Deposit redemption reserve
  • Credit rating is required
  • Capital adequacy requirement - a minimum net worth or turnover is a must for the company
  • Company's borrowing limit may be linked to it's net worth
  • The company must disclose if it has defaulted on it's obligations in the past 
  • Purchase of deposit insurance cover by the company
This is a fantastic move by the Government and would go a long way in protection of customers. Next time you deal with any entity asking for advance money, keep the provisions of Companies (Deposit Acceptance) Rules in mind.

Is it beneficial for an investor to invest in a mutual fund NFO?

Here is my article published in Mumbai edition of Mid-day Gujarati today. The paper is attached herewith. Below that, the English translation is given:

Is it beneficial to an investor to invest in a mutual fund NFO?
“Fund houses happy as NFOs get speedy nod from SEBI” – this was the news headline some time back. The news also added that there is a surge in the NFOs from fund houses.
At some stage, SEBI took a view that the fund houses were launching too many similar schemes and they started reforms, including a declaration from the trustees that the proposed scheme (if open-ended) is different from any of the existing schemes. It also cut down the time of the launch as well as the time for allotment of units after the closure of the NFO. However, it still took quite long to clear the offer documents. This process has now been streamlined as the news referred.
Well, that is as far as the news is concerned, but what is in it for the investors? What should an investor do if the number of NFOs goes up?
Before that, let us first understand what an NFO is. NFO means a New Fund Offer – this is the time when a new mutual fund scheme is offered to public for investment for the first time, whether the scheme is open-ended or close-ended. This is similar to equity share IPO, where the company offers subscription to its shares to public for the first time.
The NFO matters to an investor only in certain cases:
1.     In case of a close-ended fund, where the units are not available for subscription directly from the fund on an on-going basis after the NFO period
2.     Recently, there was a new scheme launched – CPSE ETF, to help the Government of India’s disinvestment program. In this case, the NFO investors were given two incentives
                         i.         There was a 5% discount to NFO investors,
                       ii.         The NFO investors, who stay invested for a year, would be allotted bonus units in the ratio of 1 unit for every 15 held in the account
In the first of the above cases, since the investor does not get a chance to invest in the scheme, one may consider investment during the NFO period. In case of a close-ended scheme, thought the units are listed on the stock exchanges, there is hardly any trading activity. In that case, NFO could be the last chance to buy into the scheme for an investor.
In the second case, there would be a market-making mechanism that provides liquidity. This would allow an investor to buy ETF units from the stock market after the NFO is over. However, the additional incentive is available only if the investment is made during the NFO period.
In all the other cases, there is no compelling reason to buy during the NFO period, since one can invest anytime after the scheme becomes open.
At the same time, this discussion should not be construed as recommendation to invest or not invest in any mutual fund scheme – either during the NFO or thereafter. An investor is advised to consider one’s own situation before taking any decision. Just because a new scheme is being launched, one does not have to jump to invest.
A new launch cannot be the reason of one’s investment. Can someone imagine going for dialysis just because a new kidney hospital has opened next door and one has been invited for the inauguration function? At the same time, nobody would wait for a new hospital to open when there is a need for dialysis.
Treat a new launch in an exactly the same manner. Identify your own objectives and then decide what kind of investment portfolio you want to build. After that comes the decision of scheme selection. It does not matter whether it is an existing or a new scheme. However, an existing scheme would allow an investor to analyse the past performance to take an informed investment decision.
Happy investing!
Amit Trivedi
The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.

How to protect yourself from investment scams

It looks like routine that at least once a month some news is written on how investors fall in to the trap of investment scam. Before investing in any such scheme that offers mouth watering returns it is important to do proper study on the same. Read this space to know how to stay away from such fraudulent schemes.