At times Investors have lot of misconception regarding NAV and at times lot of misspelling happen in market because of these misconception hence the article is about cleaning those myths and doubts
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 AMC(Asset Management Company ) for each scheme daily 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 8 PM.
If one 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 does one 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 AMC goes around asking people to invest in the new scheme (because it’s going to be such a great fund! Very aggressive marketing the expense margin is also more in NFO).
Let’s say it collects about Rs 100 Cr during the NFO for the fund. So it will create 10 Cr units @ Rs 10 each and allot them to investors who participated in the NFO in proportion to their investments i.e. if lets Investor A invested Rs 5000 he will get 500 units (at an NAV of Rs 10) Investor B invested Rs 100000 he will be allotted 10000 units
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. So lets assume for understanding purpose Rs 100 crore is invested in a portfolio comprising two stocks (in Reality the portfolio has 30-40 stocks) Rs 60 Crore in Alpha limted whose share is trading at Rs 100 and remaing Rs 40 Crore in Beta Ltd whose share trading at Rs 200 so portfolio will have (Rs 60 crore/Rs100) 60 lakhs shares of Alpha limited and (Rs 40 Cr/Rs200) 20 lakhs shares of Beta Limited . Now these shares are traded daily in market hence their share price will fluctuate daily so on any given day lets assume Alpha limited is trading at rs Rs 120 and Beta Limited at Rs 220 and therefore total portfolio valuation will be (60 laks*120 + 20 lakhs* 220) Rs 116 crore. The AMC also has to adjust expenses of scheme also in NAV and the entire expense is ammortised on daily basis so again for understanding purpose annual expense of scheme is Rs 500 crore which when distribute over a year (250 days of working) will be 2 crore adjusted on daily basis hence Net Portfolio value will be Rs 114 crore which when divided by number of Units (10 cr) it will have NAV of Rs 11.4 and hence Mr B who has 100000 units will have its portfolio value of Rs 114000
Now it is poosible that shares of companies may fall also and hence it can impact NAV accordingly
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 movement of Security Price in Portfolio
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 companies having exposure to Vodafone Idea bonds
Among the open-ended schemes, UTI Credit Risk Fund has been hit the hardest due to its 17.55 per cent exposure to Vodafone Idea debt. Its NAV fell 10.42 per cent, wiping out more than a year’s return. UTI Bond fund fell 4 per cent, Nippon Hybrid Bond fell 3.83 per cent, while Aditya Birla Regular Savings and Aditya Birla Equity Hybrid 95 fell by 1.2 and 1.02 per cent, respectively
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 portfolio value held by the fund go up by 10%, then at the end of the day, the fund will declare the NAV to be up by 10% as well irrespective of the actual value of NAV. If the NAV was Rs 10, then the new NAV will be Rs 11. If the NAV was Rs 1000, then the new NAV will be Rs 1100.
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.
So logic of NAV is lesser is better does not apply as NAV is not determined by demand and supply of units as there is no restriction on supply of units and new units can be created as per demand
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’.
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.
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, one should not be confused in selecting fund based on value of NAV 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; The value of NAV should not have any bearing on decision of choosing the scheme
A fund that pays dividend is better –
Some of you may think that you’ve got a bang for your buck when you get a dividend as soon as you buy into a fund. In reality, what happens is that a part of your money is returned soon after you invest.
This is one among the many misconceptions surrounding a fund when it comes to dividend and the fund’s NAV. For one, many investors believe dividends are the actual returns from a fund, like the way interest is to a deposit. Hence, higher the dividend, the better it is. This is a misconception.
Dividends are nothing but a part of the gains in your NAV that is given back to you in the form of cash (payout), or units (dividend reinvestment). That means you are not getting anything over and above what your fund has earned. No free lunches here.
In fact your NAV falls to the extent of the dividend that is given out. In the case of debt funds, the dividend distribution tax is also reduced from the NAV.
Hence all schemes which have dividend option will have lower NAV as compare to Growth option in the scheme where no dividend is declared
It’s also advisable that investors who are looking for long term wealth creation should not look for Dividend option but should opt for Growth Option of the scheme
Two, some investors believe that the NAV under dividend option is cheaper. It follows from the first point above that the NAV falls after every dividend is declared. Hence, the NAV will seem low compared with the growth option where the profits of the fund are added to your NAV and not stripped.
Three, funds are not mandated to pay regular dividends. Some funds may pay out more if they think markets have run up a bit and others may strive to give periodic gains by way of dividends. But remember, dividend pay outs, especially when it comes to equity funds, do not allow you to build wealth efficiently as it simply sits in your savings account and does not redeployed.
Wealthymind 