Mutual fund investors will definitely come across the term NAV more than once. And no matter how much they try to keep this jargon away, they simply cannot. This is one term that will keep cropping up often, for instance, while buying and selling mutual funds. Naturally, there are also a lot of misconceptions about what the term actually means. As a mutual fund investor, you need to know what a NAV means.
The NAV formula
NAV, or the net asset value, is the total of the market value of the shares that are held in a portfolio. This includes cash, minus liabilities, divided by the total number of outstanding units. In other words, the NAV of a mutual fund is nothing but the book value of the unit.
Is a low NAV good?
A lot of investors feel that a fund that has a low NAV is cheaper than the ones that have higher NAVs. Moreover, at the time of a new fund offer, distributors tend to push the new fund forward by pointing to its low NAV, which indicates that it is available for a bargain.
The truth, however, is that NAV in itself is of no consequence. The notion that a low NAV fund is cheap arises when investors compare the NAV with stock prices. However, a low stock price when seen in terms of its valuation means that the stock is available at a bargain. This does not hold for a fund’s NAV. NAV will not tell you whether or not a fund is cheap. It will only reflect the current value of one unit of the portfolio.
Here is an example to illustrate how returns are independent of NAVs.
Let us say that you have INR 10,000 to invest and you have two options, Fund X and Fund Y. both portfolios are the same, but the NAVs are different. While Fund X has a NAV of INR 10, Fund Y has a NAV of INR 50. This means, with the money in hand, you can either buy 1000 units of Fund X or 200 units of Fund Y.
After one year, if the portfolios are the same, both funds will grow equally.
Let us say that these funds grew by 25 percent. Thus, after a year, the NAVs will be INR 12.5 for X and INR 62.5 for Y. the value of your investment will be INR 12,500 for Fund X (1000 x 12.5) and also INR 12,500 for Fund Y (200 x 62.5). Thus, irrespective of the NAV, your returns will be the same.
When you buy a mutual fund at its NAV, you are buying it at its book value. This means you are paying the right price for its assets, irrespective of the amount. Thus, what we are looking at here is performance and not NAV. And the best way to do that is to compare returns over similar periods.