As a mutual fund investor, one often comes across the term NAV (Net Asset Value) . However, not everyone is well-versed with the concept of NAV and the role that it plays in mutual fund investments.

In this article, find out in detail what is NAV in mutual funds and why it is important for mutual fund investors.

 

What is NAV in mutual funds?

The combined securities (equities, bonds, etc.) and assets a mutual fund scheme owns is known as its portfolio. When investors invest in mutual funds, they are allotted units that represent a portion of the portfolio, i.e. the extent of investor’s ownership in the scheme. The value of each unit is represented by the NAV of the mutual fund.

The NAV of a mutual fund scheme is the value of its assets minus liabilities and expenses, i.e., the net worth (also known as book value) of the scheme. In other words, the NAV of a mutual fund reflects the current market value of all the securities that it holds.

How is the mutual fund NAV per unit calculated?

The market value of all the securities held by a mutual fund minus the liabilities and expenses is divided by the number of outstanding units (the number of units the scheme has issued to investors) to calculate the NAV per unit.

Due to the dynamic nature of the stock and debt market, the market value of securities fluctuates frequently, and so does the NAV of mutual funds. Mutual fund schemes are required to disclose the closing NAV for each day by 11 pm. All purchase/sale/switch transactions of mutual funds take place at the closing NAV of the scheme.

The NAV per unit of a mutual fund is calculated as below:NAV per unit = [Total Assets – (Total Liabilities + Expenses)] / Total Number of Outstanding Units

For example, if the market value of all securities held by an equity mutual fund scheme is Rs 15 lakh, and the mutual fund has issued 1 lakh units to the investors, then the NAV per unit of the fund is Rs 15 (i.e., 15 lakh/1 lakh).

If an investor bought 100 units of the above fund at an NAV of Rs 10, the investment would now be worth Rs 1,500 (100 units* Rs 15 NAV). Or in other words, the mutual fund investment has grown by 50% (1,500/1,000-1).

Every scheme discloses the daily NAV after taking into account the expenses incurred. There is no restriction on the type of expenses a scheme charges as long as the expense ratio is within the limit prescribed by SEBI. These expenses typically include management, administration, and other costs.

How NAV applicability is determined for different types of mutual fund transactions (creation and redemption of units)?

The applicable NAV for purchase transactions (including Switch-in transactions) under all mutual fund schemes (other than Liquid Funds and Overnight Funds), irrespective of the amount of investment, is determined as follows:

Time of receipt of Transaction and Money Applicable NAV
Where the purchase transaction is received up to the cut-off time of 3.00 p.m. on a business day at the official point(s) of acceptance and funds for the entire amount of subscription/purchase are available for utilisation up to 3.00 p.m. on the same business day. NAV of the same business day will be applicable.
Where the transaction is received up to the cut-off time of 3.00 p.m. on a business day at the official point(s) of acceptance, but the funds for purchase of units are available for utilisation after 3.00 p.m. on that business day or on a subsequent business day. NAV of the subsequent business day on which the funds are available for utilization prior to 3.00 p.m. will be applicable.
Where the transaction is received AFTER the cut-off time of 3.00 p.m. on a business day at the official point(s) of acceptance and funds for the entire amount of subscription/purchase are available for utilisation up to 3.00 p.m. on the same business day. NAV of the subsequent business day will be applicable.
Where the application is received after the cut-off time of 3.00 p.m. on a business day at the official point(s) of acceptance and funds for the entire amount of subscription/purchase are available for utilisation after 3.00 p.m. on the same business day or subsequent business day. NAV of subsequent business day on which the fund realised prior to 3.00 p.m. will be applicable.

(Source: AMFI)

With effect from February 01, 2021, investors in equity and debt funds are allotted mutual fund units based on the closing NAV of the day on which the asset management company (AMC) receives the fund:

Transaction Type Transaction received before cut-off timing Money received by MF before cut-off timing Applicable NAV
Purchase / SIP Instalment Y Y Same business day.
Y N Next business day on which money received by the fund before the cut-off time.
N Y Next business day on which Time Stamping is done before the cut-off time.
N N NAV of subsequent business day on which the fund realised prior to 3.00 p.m. shall be applicable.

(Source: AMFI)

In case of redemption of mutual funds, the applicable NAV is as follows:

Where the redemption transaction is received on any business day at the official points of acceptance of transactions up to 3.00 p.m. NAV of the same business day shall be applicable.
Where the transaction is received after 3.00 p.m. NAV of the next business day.

(Source: AMFI)

Do note that redemption of mutual funds may be subject to exit load. In this case, the redemption price will be calculated as follows:

Redemption Price = Applicable NAV*(1- Exit Load, if any)

For Example: If the Applicable NAV is Rs 10 and Exit Load is 2%, then the Redemption Price will be = Rs 10* (1-0.02) = Rs 9.80

Is the NAV in a mutual fund similar to a stock price in the equity market?

It is vital to understand that mutual fund NAV is not similar to the stock price of a company. Unlike stock prices, where demand and supply influence the price, a mutual fund NAV is not affected by purchase and sale transactions.

So, a mutual fund NAV does not tell if the scheme is available cheap or expensive. It simply denotes the current value of all the securities the scheme holds in its portfolio.

Another difference is that in case of stocks, investors can trade on a real-time basis allowing them to take advantage of different price points. This is not the case with mutual funds.

Is a mutual fund scheme with a low NAV better?

It is a common misconception among investors that a mutual fund scheme that has a low NAV has better growth potential. Accordingly, some investors look to purchase schemes with a low NAV (such as NFOs), especially when the equity market is trading at expensive valuations as they believe that buying a mutual fund with a low NAV means that it is available at a bargain price.

However, it is wrong to assume that a mutual fund available at a low NAV of, say, Rs 10 is cheaper than a mutual fund with a higher NAV of, say, Rs 100 per unit. A mutual fund with a higher NAV does not mean it is expensive. Similarly, a low NAV is not indicative that it is available at a bargain price.

Likewise, if two funds have similar NAVs, it does not mean that they will generate similar returns. At the most, funds in the same category may move in one direction; but the growth of the scheme will depend on the type of scheme, the fund manager’s investment strategy/style, and the quality of the underlying portfolio, among other factors.

To understand this, consider the example below:

NAV does not have an impact on the performance of mutual funds

Scheme Name Latest NAV (Rs) 1 Year (%)
Nippon India Large Cap Fund 70.1686 28.23
HDFC Top 100 Fund 907.3010 24.60
Edelweiss Large Cap Fund 70.5600 24.12
ICICI Pru Bluechip Fund 83.9700 22.53
DSP Top 100 Equity Fund 357.1920 22.05

The securities quoted are for illustration only and are not recommendatory.
Returns are point to point and in Absolute %, calculated using the Direct Plan-Growth option.
Data as on July 27, 2023
(Source: ACE MF) Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully before investing. Past performance is not an indicator for future returns. The percentage returns shown are only for indicative purposes.

As we can see in the table above, there is a stark difference in the NAV of the two Large Cap Mutual Funds – HDFC Top 100 Fund (907.30) and Edelweiss Large Cap Fund (70.56). However, when we compare the performance data of the two funds in the last 1 year, it is relatively close. In short, the NAV cannot be a criterion to compare the performance of schemes.

Generally, funds that have been in existence for a long time, for instance 10-15 years or more, have higher NAVs which suggests that they have performed well in the past. By avoiding a scheme that has a high NAV, investors may be penalising it for its consistent performance track record. However, remember that there is no assurance that it will generate good returns in the future either.

On the other hand, new fund offers (NFOs) have low NAVs. Most of them are launched at a NAV of Rs 10 per unit.

However, if the old scheme and the new scheme have invested in the same companies with similar weightage, they are likely to generate similar returns. The NAV will not have an impact on their growth potential in any way.

Can NAV in mutual funds be used to make investment decisions?

NAV can be used to calculate the returns on an investment in a mutual fund. The growth in NAV over a period can be a helpful tool in determining the performance of schemes within a particular category. For instance, an increase in NAV indicates strong performance by a mutual fund scheme which results in gains for the investors. Likewise, a decline in NAV indicates poor performance by a fund.

However, it is important to note that past performance is not an indicator of future returns. In addition, it is important to note that no two mutual funds are same, as each scheme follows its own investment style and portfolio strategy.

Consider this instance to get better clarity on mutual fund NAV calculation:

Let’s assume that an investor wants to invest Rs 5,000 each in two Large Cap Mutual Funds that have similar portfolios. Fund A has a NAV of Rs 10 and Fund B has a NAV of Rs 50. At the time of investment, the investor will be allotted 500 units of Fund A and 100 units of Fund B.

If, after one year, both funds have grown by 10%, the growth in NAV will be as below:

The NAV of Fund A will be 11, and the NAV of Fund B will be 55.

The value of the investment will be:

Fund A:  500 units x Rs 11 = Rs 5,500

Fund B:  100 units x 55 = Rs 5,500.

Thus, both the funds have generated similar returns irrespective of the NAV because they had similar portfolios.

Therefore, mutual fund NAV cannot be used as a sole parameter to select the best mutual fund scheme. Instead, investors should focus on the following parameters to select the best equity mutual fund: https://www.youtube.com/embed/sYk4zPWwEJk

1) Risk-reward matrix

Evaluate the mutual fund’s past performance over various time frames such as 1-year, 3-year, 5-year, since inception, etc., along with performance comparison across past market phases vis-a-vis its peers and the benchmark index. This will give investors a comprehensive idea of how consistently the mutual fund has performed. However, avoid relying too much on past performance because it is not indicative of future returns.

Also determine how well the fund has rewarded its investors for the risk they have taken using risk-reward ratios like Sharpe Ratio, Sortino Ratio, Standard Deviation, etc.

2) Portfolio characteristics

The growth potential of a mutual fund depends to a great extent on the quality of its underlying portfolio, i.e., stocks and other securities. A mutual fund scheme should be well-diversified across stocks/sectors and other securities depending on its investment mandate to avoid concentration risk.

The fund should also have a reasonable turnover ratio. High turnover can make a fund more volatile and also lead to a higher expense ratio, which can impact the overall returns.

3) Efficiency of the fund management team

Always choose mutual fund houses that have a superior performance record and follow robust investment processes with adequate risk management systems in place.

Moreover, because a mutual fund’s performance is directly dependent on the ability of its fund manager, it makes sense to check the qualification and experience of the fund manager and the track record of the other schemes they manage.

[Read: How to Invest in Mutual Funds]

[Read: How to Sell Mutual Funds Online: A Step-by-Step Guide]

To conclude:

To get the best out of mutual fund investment, avoid falling for the ‘low NAV = cheaper fund’ narrative. Instead, create a diversified portfolio of best equity schemes selected using the aforementioned parameters. More importantly, the scheme that investors choose should be in congruence with their risk appetite, financial goals, and investment horizon.

This article first appeared on PersonalFN here


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