Mutual fund NAV: FACTS and MYTHS

There are several aspects of mutual funds which are misunderstood by investors -- NAV size is one of them.

Some investors believe that lower the NAV, the cheaper it is. Hence, in turn, the fund is equipped to deliver better returns vis-a-vis a fund with a higher NAV.

Before we debunk this myth, let's first understand what the NAV is and how it is calculated.

 Courtesy 

How is NAV calculated?

Simply put, the NAV is the value of each unit of a mutual fund. The NAV is calculated as the net assets of the fund (assets less expenses) divided by number of units.

A hypothetical example will help us better understand this. Say, the fund's total assets amount to Rs 4,10,000 and expenses chargeable to fund amount to Rs 10,000; assume, the number of units issued to be 20,000. This results in an NAV of Rs 20 per unit i.e. (4,10,000 less 10,000) divided by 20,000.

In other words, the NAV represents the intrinsic value of each unit of the mutual fund.

The NAV is not the same as a stock price

Now for the misconception of a lower NAV being cheaper than a higher one. Often, investors make the mistake of drawing a parallel between a mutual fund's NAV and a company's stock price. In the case of a stock, the book value (which is representative of its intrinsic value) can be distinct from the market price (determined by demand and supply factors). Hence the concept of a cheaper or an expensive stock.

But as we have discussed earlier, in a mutual fund, the NAV represents the asset value underlying each unit i.e. the intrinsic value of each unit. Hence unlike stocks, there is no divorced intrinsic value and market price.

Of course, the 'lower NAV equals a cheaper buy' myth has been put to good use by several fund houses and distributors over the years. This was particularly apparent in the case of new fund offers (NFOs). Several investors became victims of mis-selling since they were led to believe that the Rs 10 NAV in an NFO amounts to making a cheaper buy.

Lower NAV and performance

Now let's find out if a lower NAV has necessarily helped funds deliver better returns or for that matter if a larger NAV has been a detriment to performance.

Let's consider the growth option NAVs of some funds. In April 2007, HDFC Top 200 Fund had an NAV of Rs 111.8. In the subsequent three-year period, the fund posted a growth of 18.9 per cent on a compounded annualised basis. On the other hand, Reliance Equity with a substantially lower NAV (Rs 11.7) grew by just 8.5 per cent on a compounded annualised basis. Clearly, the higher NAV didn't stop the fund from pitching in a better performance than a fund with a lower NAV.

So does that mean that a higher NAV is better? Not at all!

Quantum Long Term Equity Fund (with an NAV of Rs 12.4 in April 2007) outscored several funds with higher NAVs and delivered a growth of 16.6 per cent on a compounded annualised basis.

Investors must therefore understand that the fund's NAV has no bearing on its performance. The performance is determined by factors like the fund manager's skills, the investment processes and style, among others.

The NAV is irrelevant while making investment decisions. A lower or higher NAV doesn't make a fund an attractive or unattractive one and vice-versa.

Put differently: the NAV size simply doesn't matter.