February 19 , 2013
Many mutual investors do not have clarity about how NAV of a fund is related to its returns. Most seem to be under one of these two impressions- higher NAV funds are giving higher returns or low NAV funds are cheap to buy. Both are flawed impressions.
What is NAV?
NAV or Net Asset Value tells you the worth of a single unit of that mutual fund. If a fund PQR has NAV of Rs 25 today it means you can purchase one unit of that fund for Rs 25 today. But when you invest in a mutual fund, you do not ask for 100 units or a certain number of units of that particular fund. Rather you tell them you want to invest Rs so and so. If you have Rs 10,000 for investment in PQR fund you get to buy 400 units of that fund today.
How is NAV calculated?
All mutual funds follow the formula set down by SEBI to calculate Net Asset Value. NAV is the total assets of the fund less its total liabilities divided by the number of units of the fund. So when the value of assets such as shares, bonds or of the value of its liabilities to be paid out to investors and others changes the fund's NAV changes. Such changes happen every day and as such the NAV changes every day. All mutual fund schemes declare their closing NAV by 9 pm each day.
How to make sense of NAV?
Now coming to a common problem for many to-be investors, what to do with the NAV while choosing a mutual fund? The answer is straightforward- ignore it. When it comes to NAV of mutual fund what matters is the change in NAV over a period. No matter what the NAV was when you bought a fund, your returns would be great if the NAV grew considerably from that point by the time you sold your units.
So suppose you buy units in PQR fund at the NAV of Rs 25 today and sell it 5 years later when the NAV reached Rs 125. Your annualized return from this investment is 38%. Now imagine PQR fund's NAV was Rs 10 when you bought it and you sold it 5 years down the line when it reached Rs 50. Your annualized returns would again be 38%.
This illustration shows that the effect of NAV growing from 25 to 125 is the same as NAV growing from 10 to 50 over 5 years. So a fund having higher NAV does not necessarily mean it has given great returns in the past or would do so in the future. Nor does it mean low NAV is always a sign of bad performance.
NAV in growth option and dividend option of mutual funds
When you opt for growth option of a particular mutual fund scheme you do not 'get' returns until the day you redeem units. Your fund keeps growing and making returns but you do not take it away in the interim. You allow profits to be part of your original investment and grow. As a result in growth option the fund size or asset size grows over time. This means NAV of growth mutual funds increase over time if the fund is performing well.
As against this, in dividend option of mutual fund you take away the profits as and when the fund declares them so size of the fund remains more or less the same. Increase in NAV in dividend option could be due to other reasons like more investors joining the fund. Take for instance Franklin India Taxshield Fund. Its growth option has NAV of approximately Rs 230 while the same fund's dividend option launched at the same time has NAV just close to Rs 29.
Whether to go for growth option or dividend depends on your need for cash flows, type of fund and tax consideration. For more on this read Mutual Fund Dividend Option vs Growth Option.
NAV of new funds and old funds
New funds would have lower NAVs. Most funds start at an NAV of Rs 5 or 10. Over time NAV grows through profits it makes and increased subscriptions. That's why older funds tend to have higher NAVs than new funds. For example most mutual fund schemes launched in the 1990s have NAVs running above 200s. If a fund launched many years back has low NAV then it could possibly mean that it is not performing well. Again notice that we are comparing its NAV as of now with what it was when it started out from Rs 10.
But this does not imply that an old fund with high NAV is always a good fund. Here consider Reliance Vision fund launched late in 1995. It was an investors' favorite until performance deteriorated a few years back. Now its performance is sadly worst among other funds belonging to the same category. Its growth option has NAV of about Rs 256, comparable to NAVs of HDFC Top 200 and HDFC Equity, both great performing funds today and launched around the same time.
So the underlined fact is that NAVs don't tell anything useful about the fund's performance unless it is compared with the NAV of a past date to calculate returns of the scheme.
Lower NAV means more units. Isn't that good?
Another big misunderstanding many investors carry is that since lower NAV gives them more units they'd be better off buying funds with lower NAVs. It is true that lower the NAV, higher is the number of units that will be allotted to you for a certain amount of investment. If PQR fund's NAV were Rs 10, you'd have 1000 units for your investment of Rs 10,000 instead of 400 units.
But the point is, it would not do any good to have 1000s of mutual fund units unless they belonged to a fund that is a good performer. Your money might buy only few units in a good fund with high NAV but your investment would give better returns in it than an average fund in which you could buy more units for the same amount of money.
It is the change in NAV over time that reflects the fund's performance and not NAV of a single day taken in isolation. But if there is a fund that has always been a great performer and its NAV is lying low in a particular period (can happen when the markets are down) you can make the most by investing in it at that time and buy more units since you know (or at least expect; based on its past performance and pedigree) that it will bounce back.
How to decide whether a fund is good or not?
There are other parameters that cannot be ignored, unlike NAV. You'll get a fairly reliable idea which is a good mutual fund scheme looking at how it has performed in the past, ratings, pedigree of the fund house, fund manager etc.
We are not trying to suggest this is how you should decide on what mutual fund category to choose. This is about zooming in on the best fund scheme from the category of fund you have already chosen. To learn how to choose the right category of fund read Choosing an Appropriate Mutual Fund.
It is after investing in a good fund that you should keep a tab on the fund's NAV and compare it with NAV from your investment date to know how the fund is doing, but don't go overboard with this either, if it is an equity fund. Just once or at the most twice a year will do.