Monday, September 19, 2016

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Equity investments simplified

How is the NAV of a mutual fund scheme calculated? Do the inflows and outflows in the scheme impact the NAV?

The other day, in an investment seminar someone asked a question: “How is the NAV calculated?” He also wanted to know if the daily inflows and outflows in the fund by investors impact the NAV calculations apart from the movement in the prices of securities held by the fund.

Read my article in Mid-day Gujarati edition today to understand the NAV calculation:

Mutual Fund NAV calculation

The other day, in an investment seminar someone asked a question: “How is the NAV calculated?” He also wanted to know if the daily inflows and outflows in the fund by investors impact the NAV calculations apart from the movement in the prices of securities held by the fund.
Let us look at both parts of the question and answer each. First of all, what exactly is NAV in the context of a mutual fund?
NAV is the Net Asset Value of the fund – popularly mentioned as NAV per unit. In the accounting parlance, NAV is the other name for book value. This is the value of the scheme’s total assets less the liabilities. If you simply add up all the assets and deduct all the liabilities of the fund, you get the value of the net assets. Divide this by the number of outstanding units and you get the NAV per unit.
NAV per unit = (total assets of the scheme – total liabilities of the scheme)
                    Number of outstanding units
This looks simple. Having reached till here, we need to understand what the fund’s assets and liabilities are.
A mutual fund scheme invests in many securities as per the investment objective. We have discussed this earlier. The market value of these securities (or investments) forms the major part of the fund’s assets. Apart from that there are some minor contributors, e.g. interest accrued but not received, dividend declared but not received yet, proceeds receivable on sale of investments, money parked in money market instruments and bank balance. All these are examples of the fund’s assets. The value of investments has to be taken as the current market price, which is an indicator of the realizable value of the scheme’s assets.
Now come the liabilities. We saw earlier that a mutual fund cannot borrow money for the purpose of investing. The only exception allowed is when the fund has to meet redemptions or dividend payouts and is unable to liquidate the investments due to some critical factors like a market meltdown or illiquidity in the system. Such a liability, if exists, should be added to the fund’s total liabilities. At the same time, there are some liabilities that exist on a regular basis. These are fees payable to various constituents like the asset management company, the custodian, bankers, R & T agent, directors, auditors, distributors, etc. there could also be liability on account of payment to be made for securities purchased. All the liabilities get added up and these have to be deducted from the fund’s assets.
As mentioned earlier, this would give the net assets of the fund.
Dividing this by the number of outstanding units would give the NAV per unit. This NAV has to be calculated on a daily basis. The accounts students among the readers can easily make out that in order to arrive at the fund’s net assets, the scheme’s balance sheet must be prepared. Since the NAV is calculated on a daily basis, the balance sheet is also prepared daily. Which business would be preparing final balance sheet daily? This is another example of the transparency of a mutual fund.
This answers the first part of the question – regarding the calculation of NAV.
Now let us consider the second part of the question. “Do the daily inflows and outflows impact the NAV of a scheme?” as you can see in the answer to the first question; the inflows and outflows into or out of the scheme do not feature in the NAV calculation. However, many keep asking if these inflows and outflows have any impact on the scheme’s NAV.
Well, the short answer is “no, they do not impact the NAV on a daily basis.” However, this is a simplistic answer and only looks at the theory. It is also important to check whether these have any impact on the NAV, at all.
When an investor purchases the units of the scheme, there is an inflow of money in the scheme. The scheme allots units at the prevailing NAV. This is the NAV that has been calculated as discussed earlier. The investor, who submits the purchase application before the cut-off time, gets units at the NAV calculated based on the closing prices for the day. Exactly same process is followed when an investor takes money out of a scheme.
As can be seen, the inflows and outflows do not impact the NAV.
However, when a scheme receives huge inflows in relation to its corpus, the fund manager may not be able to invest all the money immediately. This means, cash would be held in the portfolio for a considerable amount of time. This impacts the future NAV changes since cash and securities may not move together.
This is a small point that must be kept in mind. At the same time, since short term price movement is unpredictable and there is an (almost) equal probability that the prices may move up or down in the short run, this impact may get cancelled out over the years.
-        Amit Trivedi
The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.

Monday, September 5, 2016

Happy Teachers' Day

History has been one of the finest teachers for mankind. We have learnt so much from what our earlier generations have done.
On this Teachers’ Day, I bow down to all the teachers – present and the past, who have helped me learn and grow in life. Your contribution has been immense in making this book (Riding The Roller Coaster - Lessons from financial market cycles we repeatedly forget) possible.

How to invest in mutual funds? Direct plan or through distributor?

The debate continues on whether a direct plan is better for investors or should one go through a distributor to invest in mutual funds? Read my views on the same below:

The English translation is as under:

Mutual fund companies have introduced direct plans some time ago. There have been many discussions around these plans and the advantage of low-cost that these offer. Let us understand these plans and see the benefits to investors. We would also look at the other side: Are there any pitfalls? Is there anything that an investor needs to understand?
First of all, what are direct plans? How do they differ from the regular plans? As you know, mutual funds are sold through a distribution channel comprising of various individual mutual fund distributors, banks and various companies in the business of mutual fund distribution. As per the SEBI regulations, these distributors are required to recommend mutual fund products to their clients based on the analysis of suitability of the schemes to the investor’s needs and situation. For this work and to service and advice the investor on a regular basis, the distributors earn a commission from the mutual fund companies.
A few years ago, SEBI introduced a “direct” plan that would allow investors to bypass the distributors, if they feel they do not need to advice and services of these distributors. Due to this, the expense ratio for the direct plan is lower than the regular plan. The gap between expenses for the direct plan and that for the regular plan may vary from scheme to scheme and from one fund type to another.
One may be tempted to calculate that this difference could make a huge difference over the years. However, prudence requires that one always look at the cost in the context of the value received. Cost for anything can never be high or low in isolation. Does one get value commensurate with the cost?
So what value does a mutual fund distributor provide, really? Many are under the impression that a mutual fund distributor’s greatest value is in selecting the best mutual fund schemes. This cannot be farther from the truth.
First of all, what exactly is “the best scheme”? Are we looking at a scheme that would offer the highest returns in the future? What is the basis of identifying this? Past performance? If that is the way to select schemes, you do not need any help. The data is easily available on many websites – for free.
The “best scheme” is the one that is most appropriate for you – given your unique situation. More often than not, it is not one scheme, but a combination of schemes that an investor needs. A good distributor can help decide on a good combination of schemes. You see, in our regular diet also, while one needs to have varieties to get proper nutrition, one still cannot mix milk and lemon.
A seasoned distributor, a veteran, and experienced one would also be able to put things in perspective better than most investors can do themselves. A veteran is supposed to have a balanced head on the shoulders. This allows one to focus on what matters and think clearly without getting swayed away by the external turbulences. This ability to stay focused helps the distributor to get the client also to focus on what matters most in life. Such a focus then allows the investor to comfortably achieve life’s financial goals.
There are many operational issues that take away a lot of time. In case of such issues, a distributor may know how to handle critical situation since one may have handled the same case for few other clients. For an investor, each issue may present a new challenge taking away too much of precious time. If one calculates the “money value of one’s time”, it may turn out to be much more than the gap between the expenses between direct plan and regular plan.
Think about it – do a rough calculation – you might be surprised.
Amit Trivedi
The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions. He is the author of a book "Riding The Roller Coaster - Lessons from financial market cycles we repeatedly forget"