NAV unplugged

30 August, 2007:

It is one of the most misunderstood concepts in the financial world. NAV or Net Asset Value can be an invaluable tool for an intelligent mutual fund investor. However, it can also be frighteningly misleading at the hands of an ignoramus. Otherwise, how can you explain the common perception that a low NAV is a smart investment opportunity and a higher NAV is a risky option?

It is mostly because most people confuse NAV of a unit of a mutual with stock prices. It is a big mistake. A stock price is an indication of future prospects of a particular company. Investors may be using formulas or technical charts to justify the price. Alternatively, it may be pure speculation based on some unconfirmed news.

However, NAV of a mutual fund is a very different concept. It tells you the total value of investment of the unit of a mutual fund scheme. In order to calculate the NAV of a scheme, every asset and liability of the scheme should be valued. The formula for calculating NAV is: value of all assets minus value of liabilities other than to unit-holders. The other way to calculate NAV is: Unit capital plus reserves.

If it is that simple, why is it misinterpreted? Consider this example: you are considering investing in a diversified equity fund. The NAV of a unit of ABC mutual fund’s scheme is Rs 10 and XYZ is Rs 12. What does that mean? It means that ABC fund’s corpus is Rs 50,000 and total number of units is 5,000. Hence, it has an NAV of Rs 10 (Rs 50,000/5000). On the other, NAV if XYZ fund’s scheme is Rs 12 because it has a corpus of Rs 60,000 and units of 5,000.

Now, should you make your decision based on the difference in NAV? As you can see, it has nothing to with the future performance of the fund. It simply means that schemes investments are worth a particular amount and you have to pay that price to buy a unit of the scheme. The future performance of the fund will determine your future returns. There is nothing stopping XYZ fund from outperforming ABC fund.

In short, lower or higher NAVs should not influence your investment decision. Your criteria to invest in a scheme should be based on the reputation of the fund house and its performance record. One should also take a look at the portfolio and style of managing money.