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.
The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.