NAV myths demystified

High or low NAV should not be a determining factor for taking investment decisions

You need to tell your clients that the current NAV of a scheme whether high or low should not be a determining factor, says Nikhil Kothari, Research Analyst with

iFAST Financial.

Your clients are often confused with the term Net Asset Value (NAV) as it may become difficult for them to judge whether a fund with higher or lower NAV is better. Then, what should you be telling your clients?

NAV simplified

Basically, NAV is the price at which investor buys or sells units of mutual fund. It is derived by dividing the total assets (sum of total value of all securities and cash) of the fund by the number of units issued to investors. The value of your investment is driven not only by NAV but, it is a product of NAV and number of units.

We explain why comparing the fund NAV is actually a futile effort.

Myth busting

Myth I: An investor has a misconception that a fund with higher NAV will give fewer units. Though this is true, it is not the correct criteria to select a fund.

Let us understand this with an example: Suppose, Fund A has a NAV of Rs 100 and there is another fund B with NAV of Rs 20. An investor puts Rs 1,00,000 in both the funds so accordingly, he will receive 1000 units of Fund A and 5000 units of Fund B ( Investment value / NAV = Number of Units). Now, assume that return generated by both the funds is 20% in a year’s time. Therefore, NAV of Fund A and Fund B after a year would be Rs 120 and Rs 24.

If we calculate the value of the portfolio for both the funds, the value of Fund A after an years time will be Rs 1,20,000 (RS 120 * 1000) and Value of Fund B will be Rs 1,20,000 (Rs 24 * 5000).

It is clearly evident that it is not the NAV but the expected return generated in future should be a determining factor to choose the fund.

Myth II: Again, many investors have the misconception that higher NAV has already appreciated as compared to a fund with lower NAV and thus, the fund with lower NAV is cheaply valued.

Here, we consider NAV of three funds and then compare the performance of those funds after a certain period. Suppose after one year, the NAV of three mid-cap funds i.e., Sundaram Select Midcap Fund, Kotak Midcap Fund and JPMorgan India Smaller Companies Fund as at 30 October 2009 was Rs 117.52, Rs 19.17 and Rs 5.91 respectively. The return generated after one year is 43.09%, 50.89% and 43.22% respectively (as at 30 October 2010). If lower NAV funds were cheaply valued then JP Morgan India Smaller Companies fund should have given highest return but Kotak Midcap Fund has given maximum return out of the three funds even though it’s NAV was higher than JP Morgan India Smaller Companies Fund. In addition, albeit there was huge difference between the NAVs of Sundaram Select Midcap Fund and JP Morgan India Smaller Companies fund, the one year return generated by both funds has been similar. Hence, it is not the NAV but the way the fund is managed determines the future prospect of the fund.

Myth III: New Fund Offers (NFO) are attractive as they are available at Rs 10

Many investors are also of view that s/he should invest in an NFO as the same is available at Rs 10 whereas the existing fund with the same objective is at a higher NAV. Plus, some investors even prefer to sell the old fund and buy the new fund.

Say, the Fund A was launched in the year 2000 and the current NAV of the fund is Rs 100.

Now new fund i.e. Fund B is launched which has same mandate as Fund A. As Fund B is an NFO, the NAV of fund is Rs 10.

Assume that both the portfolios are invested in same 5 stocks and have 20% weightage in each stock as at 30 October 2010.