A Fortnightly Newsletter
16th March 2012
Mutual Funds

Does low NAV means cheap valuation?

There are many first time investors who are troubled by questions like: Is a fund with a low NAV a better investment option than a fund with a higher NAV? Since you can buy more units when the NAV is low, isn't it cheaper? Should mutual fund schemes with a higher NAV be avoided?

The answer to all these questions is that it is irrelevant how high or low the NAV of a fund is. The amount of your investment remaining unchanged, between two funds with identical portfolios, a low NAV would mean a higher number of units held and consequently a high NAV would mean lower number of units held. But under both circumstances, the product of the number of units and the applicable NAV, which is the value of your investment, would be identical. Thus it is the stocks in a portfolio that determine returns from a fund, the value of the NAV being immaterial.


Definition of NAV

NAV, or Net Asset Value, is the aggregate of the market price of all the shares contained in the portfolio, inclusive of cash after deducting the liabilities divided by the sum of units issued. It can also be called as the book value of the unit of the fund.

NAV = sum of the shares in portfolio + cash -- liabilities / sum of units issued

Myths of NAV

Many people tend to think that the fund with low NAV is much cheaper than the fund with higher NAV. So people tend to think that if a fund has a NAV of Rs 50, it is cheaper than the similar fund with the NAV of Rs 80.

This misconception stems from the fact that most people tend to equate NAV with the market price of the share. As a result, there have been instances when people have redeemed their investments in well-performing funds to invest in NFOs. Even many mutual fund salesmen tend to mislead people by telling them that funds with low NAV are cheaper than those with high NAVs, thus enticing them to invest in the funds that they are selling.

Impact of NAV on its returns

While it is commonly believed that funds with lower NAVs will yield better returns, it is not true. For example, take two funds with NAVs of Rs 50 and Rs 100, respectively. You invest Rs 1,000 in both of them. So you get 20 and 10 units, respectively.

Assume both the funds give a return of 50 per cent after one year. The new NAVs of these funds, thus, become Rs 75 and Rs 150, respectively. Now the value of your investment in first fund becomes Rs 1,500 and that in the second fund also becomes Rs 1,500. Hence the returns in both the cases are same, irrespective of the NAV of the fund. So it is not the NAV instead, it the quality of fund that will greatly impact your returns.

The cost of a scheme in terms of its NAV has nothing to do with returns. What you want to buy in a scheme is its performance. The only instance where a higher NAV may adversely affect you is where a dividend has to be received. This happens because a scheme with a higher NAV will result in a fewer number of units and as dividends are paid out on face value, higher NAV will result in lower absolute dividends due to the smaller number of units. But even here, total returns will remain the same.

So from whichever angle you see it, the NAV makes no difference to returns. Mutual fund schemes have to be judged on their performance. And the simplest way to do this is to look at other indicators, such as mandate of the fund, the fund's past performance, how long the fund is in existence, size of the fund, the fund manager's experience and history in managing the fund etc., before making final decision to buy a fund.

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References:

1.) Wikipedia
2.) Fundsupermart.com
3.) www.investopedia.com

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