NAVs: Busting a few myths

An investor has two choices – Fund A with NAV of Rs. 20 and Fund B with NAV of Rs. 40. Which fund should he invest in?

Based on just the facts stated in the question above, NO decision can be taken.

1. The absolute value of NAV has no significance unless viewed in the context of a more complete picture.
2. In the past, NFOs were often touted as a ‘bargain’ since units were on offer at a face value of Rs. 10 whereas an existing fund with a high NAV of say Rs. 50 was projected as an ‘expensive’ or ‘overvalued’ fund. The fact is that market movements will affect both the funds and assuming the two funds hold identical portfolios, they will deliver identical gains or losses.

Let us explain it through an example.

Mr. Big invests Rs.10000/- in Fund A which has an NAV of Rs.10/-. At the same time Mr. Small also invests Rs.10000/- in Fund B which has an NAV of Rs.50/-.

Mr. Big gets 1000 units of Rs.10/- each. On the same lines Mr. Small will get 200 units of Rs.50/-

Now both funds, A and B, buy 200 shares at Rs.50/- in a company ABC Ltd. One year later the share price of ABC Ltd. rises to Rs.120/-.

So now, Fund A’s NAV becomes (200 shares * Rs.120/-) divided by 1000 units, i.e., Rs.24/-. Fund B’s NAV becomes (200 shares * Rs.120/-) divided by 200 units, i.e. Rs.120/-. Therefore Fund B’s NAV is Rs.120/-.

Both Mr. Big and Mr. Small have seen gains of the same magnitude, i.e. 140% even though the starting NAVs of the funds they invested in were vastly different.

This has been illustrated below.

So clearly it does not matter whether one has invested in a fund with a higher or lower NAV.

At times, a reverse but equally fallacious argument is made – the fund with the higher NAV is projected as the better performing fund even though a closer examination could show a different picture.

Let us say, Fund A appreciated from Rs. 10 to Rs. 20 in two years whereas Fund B appreciated from Rs. 30 to Rs. 40 in the same period. Now, which is a better fund? Other things being equal, Fund A seems to have performed in the more recent period. But is this enough? Perhaps not.

A deeper evaluation of a fund has to look at consistency of performance across time periods and judged against the benchmark index as well as its peers. Some of the other important evaluation parameters are quality of portfolio, corporate governance and adherence to the fund mandate.