Demystifying NAV myths

The term NAV in mutual funds has been misunderstood by a large section of the investing community. Sanjay Matai clarifies.

The NAV of a mutual fund has not been correctly understood by a large section of the investing community.

This is quite evident from the fact that Mutual Funds had been recently collecting huge corpus in their New Fund Offers or NFOs, whereas the collections in the existing schemes were negligible. In fact, investors sold their existing investments and invested in NFOs. This switch makes no sense, unless the new fund has something different and better to offer.

Misconception about NAV

This situation arises from the perception that a fund at Rs 10 is cheaper than say Rs 15 or Rs 100. However, this perception is totally wrong and investors would be much better off once they appreciate this fact. Two funds with same portfolio are same, no matter what their NAV is. NAV is immaterial.

Why people carry this perception is because they assume that NAV of a MF is similar to the market price of an equity share. This, however, is not true.

Definition of NAV

Net Asset Value or NAV is the sum total of the market value of all the shares held in the portfolio including cash less the liabilities, divided by the total number of units outstanding. Thus, NAV of a mutual fund unit is nothing but the book value.

NAV vs Price of an equity share

In case of companies, the price of its share is as quoted on the stock exchange, which apart from the fundamentals, is also dependent on the perception of the company’s future performance and the demand-supply scenario. And hence the market price is generally different from its book value.

There is no concept as market value for the MF unit. Therefore, when we buy MF units at NAV, we are buying at book value. And since we are buying at  book value, we are paying the right price of the assets whether it be Rs 10 or Rs.100. There is no such thing as a higher or lower price. 

NAV & it’s impact on the returns

We feel that a MF with lower NAV will give better returns. This again is due to the wrong perception about NAV. An example will make it clear that returns are independent of the NAV.

Say you have Rs 10,000 to invest. You have two options, wherein the funds are same as far as the portfolio is concerned. But say one Fund X has an NAV of Rs 10 and another Fund Y has NAV of Rs 50. You will get 1000 units of Fund X or 200 units of Fund Y. After one year, both funds would have grown equally as their portfolio is same, say by 25%. Then NAV after one year would be Rs 12.50 for Fund X and Rs 62.50 for Fund Y. The value of your investment would be 1000*12.50 = Rs 12,500 for Fund X and 200*62.5 = Rs 12,500 for Fund Y. Thus your returns would be same irrespective of the NAV.

It is quality of fund, which would make a difference to your returns. In fact for equity shares also broadly this logic would apply. An IT company share at say Rs 1000 may give a better return than say a jute company share at Rs 50, since IT sector would show a much higher growth rate than jute industry (of course Rs 1000 may fundamentally be over or under priced, which will not be the case with MF NAV).

Happy Investing

Source:Moneycontrol.com