One of the most widely used but not very well understood mutual fund concepts is the fund NAV or Net Asset Value. Several conflicting concepts have been propagated in the investor community regarding its importance in fund selection and sadly, many investors base their crucial investment decisions on it.
Here, we’ll attempt to clear the air and debunk the myths related to Mutual funds and NAV so that you can make sound investment decisions without falling prey to wrong investment theses.
What is NAV? How is the NAV of a mutual fund calculated?
NAV or Net Asset Value is the price at which individual units of mutual funds can be bought or sold.
This value is calculated by the Mutual Fund house every day by dividing the total net assets of a fund by the total number of units given to the investors. To find the total net assets of a particular fund, liabilities of the fund house are subtracted from the current value of the asset. Assets are available in the form of stocks, bonds, and cash, while liabilities can be in the form of management fees and redemptions. To speak mathematically, NAV can be calculated as:
Net asset value (NAV)= (Current Value of all investments – Expenses) / Number of outstanding units
The NAV value changes every day as the value of the investments in the Mutual Fund’s portfolio changes every day based on the market movements. It is published at the end of the business day by the Mutual Fund at around 10 PM.
If you invest in share market before the cut off time (usually 1-3 PM) depending on your investment platform) on a given day, the NAV of the current day will be considered, while for any investments after the cut-off then the NAV of the next day will be the applicable NAV for your investments/redemptions.
So how do you arrive at NAV for a mutual fund that’s just been launched? Do market forces factor into this initial assessment?
How is the NAV of a new Mutual Fund decided?
When a Mutual Fund scheme is launched via an NFO (New Fund Offer) the NAV is customarily fixed at Rs 10. Then the Mutual Fund goes around asking people to invest in the new scheme (because it’s going to be such a great fund!). Let’s say it garners about Rs 10 Cr during the NFO for the fund. So it will create 1 Cr units @ Rs 10 each and allot them to investors who participated in the NFO in proportion to their investments i.e. if you invested Rs 5000 you would get 500 units (at an NAV of Rs 10).
Note that as of now the fund may not even have a portfolio and all the money may just be parked in a current account or in bank deposits.
Slowly the fund manager will start investing the money in stocks of his choice as per his strategy and the value of these investments will go up or down over time.
The NAV will now reflect the change in the value of investments made by the fund. So for example, if all the stocks bought by the fund manager went up by 1% in a day, NAV will also go up by 1% (minus operational and managerial expenses) i.e. become Rs 10.1 from Rs 10. Put another way, your 500 units have now become more valuable by 1%. Your investment of Rs 5000 is now valued at Rs 10.1 * 500 = Rs 5050 (up by 1%).
Again let’s say the next day half of the stocks go up 1% and half of them go down 1% - so overall there is no change in the value of the fund’s investments (assuming equal investments were made in each stock). Hence the NAV also remains unchanged.
So changes in NAV basically reflects the fund’s performance. Over time since fund managers do tend to give positive performance, NAVs tend to increase.
New NAV = Yesterday's NAV + Today's Profit/Loss - Daily Fees*
*Management fees is deducted by the Mutual Fund on a daily basis and what you see as the current value (based on the new NAV) is net of all fees till date.
How does the NAV change?
NAV mainly changes because of the change in the value of investments held by the mutual fund company. This happens
a) Due to Market movements
This is the most general reason for change in NAV on a daily basis. NAV of a Mutual fund changes along with the price of the underlying holdings. So, NAV cannot be calculated during market hours as the stock prices change every minute. Once the trading day is complete, the NAV can be calculated taking into account the closing market prices of the securities that the fund or scheme holds.
b) Downgrades or any write-offs
NAV also gets affected in case of any downgrades or write-offs by bodies such as CRISIL and ICRA. A recent downgrade that shook up the Indian Mutual fund's sector was the
downgrade of DHFL (Dewan Housing Financial Corporation Ltd.) to ‘default’ status after the financier missed paying interest deadline of INR 150 crores on a set of non-convertible debentures.
Several debt funds had high exposure to DHFL bonds like DHFL Pramerica Medium Term Fund (37.42%), DHFL Pramerica Floating Rate Fund (31.94%), DHFL Pramerica Short Maturity Fund (30.47%), Tata Corporate Bond Fund (28.21%) and JM Equity Hybrid Fund (24.61%). They all had to mark down the value of the DHFL bonds held by them (and hence the fund's NAV) as re-payment from those bonds became uncertain.
c) On the ex-dividend date
Mutual fund houses declare the dividend amount of the stock’s held in the Mutual fund’s portfolio to be distributed a few days before the actual distribution. The day when the deduction takes place is called the ex-dividend date. When this takes place, the NAV of the particular fund falls as dividends get deducted from the fund’s assets.
Is a Mutual Fund with lower NAV a better investment?
A commonly held belief is that a fund with a higher NAV is expensive and hence will give poorer returns going forward. Instead, some investors flock towards a scheme with lower NAV in the lure of getting more MF units. This is one of those myths that need to be busted as soon as possible. Let me explain why:
Fund performance does not depend on it’s NAV. It is the other way round - fund’s NAV is modified according to its performance. A fund’s performance depends only on the portfolio of stocks/bonds held by the fund. If the stocks held by the fund go up by 1%, then at the end of the day, the fund will declare the NAV to be up by 1% as well irrespective of the actual value of NAV. If the NAV was Rs 10, then the new NAV will be Rs 10.1. If the NAV was Rs 1000, then the new NAV will be Rs 1010.
So a fund with NAV of Rs 1000 will do better than a fund with NAV of Rs 10 if its stock selection is better. NAV is irrelevant when it comes to determining whether a fund is good or bad.
But what about the fact that one gets more units in a fund with lower NAV?
Units are just an accounting construct. You may buy 1 dozen bananas worth Rs 100 or 12 bananas worth Rs 100. In both cases at the end of the day, you have bananas worth Rs 100 even though in one case you have 1 ‘unit’ and in another 12 ‘units’.
Another way to understand this is - if you buy two identical flats worth Rs 25 lakhs each will they appreciate more than say 1 flat worth Rs 50 lakhs? It would depend on each flat’s location etc, right? So if you have Rs 50 lakhs to invest in real estate, will you go for buying the most number of cheapest flats that you can find or buying the flat(s) that have the highest chance of appreciation?
Similarly in Mutual Funds the performance would depend on the fund manager’s stock selection. So just because you have more units doesn’t mean you will make more returns.
Let’s take a real life example - let’s compare 2 Goalwise recommended funds, as of 8th May 2019, there is a stark difference in the NAV of both funds, but the performance is comparable.
|Name of Fund||Launch Date||AUM||NAV
|1 year returns
|3 year returns
|5 year returns
|Axis Blue Chip Fund||Jan 05,2010||4802 Cr||27.93||9.48%||15.31%||14.49%|
|HDFC INDEX SENSEX Fund||July 17, 2002||361 Cr||333.94||11.82%||16.58%||12.76%|
As evident, the NAV should not have any bearing on your decision to select a fund. It’s just an indicator of the performance of the underlying assets, useful only to know how a fund performs on an everyday basis. The NAV of Axis Blue Chip Fund is way lesser than that of HDFC Index Sensex, but that does not have a bearing on its performance. Instead of NAV, factors like fund manager’s expertise, past performance of the fund (net of fees aka expense ratio), should be considered while selecting the right scheme.
To sum up, don’t be misled into selecting a mutual fund scheme just because the NAV is lower. Evaluate a fund based on its objective, strategy and performance over various periods of time. The stocks that the fund manager has invested in determines the returns; NAV considerations are immaterial and shouldn’t be given any thought.