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NAV Calculation

When you invest in mutual funds, you hear a lot about net asset values or NAVs. NAV is simply the value of assets of the mutual fund minus its liabilities divided by the number of shares outstanding (or mutual fund units). In other words, it’s the net value of each unit of a mutual fund scheme. When you want to buy units of a mutual fund scheme, the price that you pay for each unit is the NAV. It’s important to know about NAV calculation so that you can make better investment decisions.

A fund house launches a mutual fund scheme by coming out with a new fund offer or NFO. It comes out with a plan to invest in a certain instrument – like equity, debt, large-cap shares, small-cap stocks, sectoral shares – depending on its investment objectives. It then places this plan before investors, inviting them to participate in the scheme by putting their money in it. Units of the scheme are sold to the public at a certain fixed prices – generally Rs 10. After it gathers the funds, the fund house then invests them in the avenues defined by the investment objectives.

How is mutual fund NAV calculation done?

After the collected funds are invested in, say, stocks, the scheme does the NAV calculation, which is determined by the prices of the shares minus liabilities like the cost of administering the fund (expense ratio). As share prices change every day, the NAV changes accordingly. Investors can then measure the profits or losses by comparing the current mutual fund NAV with the NAV at which they purchased units of the scheme. So it’s important to understand mutual fund NAV calculation.

The fund declares the NAV at the end of each trading day in the case of an open-ended fund, as stipulated by the Securities & Exchange Board of India (SEBI). Here’s how mutual fund NAV calculation is done:

NAV = (Investments+cash+receivables+accrued income) – (Liabilities)

  • Investments include instruments that the fund has invested in, like shares or bonds, calculated at market value.

  • Cash is the amount the fund has in liquid assets.

  • Receivables may include the money that the fund is owed, like dividends or interest payments.

  • Accrued income is the amount that is earned by the fund, but which it is still yet to receive.

  • The liabilities include the expenses involved in administering the fund. It could also include loans from banks or any amount it owes to other entities.

NAV calculation in the case of a close-ended fund is done in a similar fashion. However, the scheme is listed on the stock exchange after the NFO and price determined according to demand and supply. The price of the mutual fund unit and its NAV may differ. If there is more demand for the scheme, prices could be at a premium to the mutual fund NAV. If the demand for the fund is lower, price could be quoted at a discount to the NAV.

Role of NAV in investing decisions

Investors use NAVs to make decisions to buy or sell mutual fund units, so understanding net asset value calculation is critical. There is a misconception among some people that a scheme with a lower mutual fund NAV is a good buy because it’s cheap. That’s not the case, and the mutual fund NAV calculation may lead to low figures simply because the mutual fund is investing in shares whose prices may be low.

The low prices may not be because of market conditions. Some companies like to keep share prices low because they want to increase its liquidity in the market. They may do it through periodic stock splits. For example, a company may split each share into two, so the value of each share will halve, and there will be twice as many shares in the stock market available to investors. Of course, the total value of shares held by existing investors will remain the same. This will affect the mutual fund NAV calculation.

NAVs are used to gauge the value of units. Suppose you have purchased units of a certain scheme at a NAV of Rs 50, and it goes up to Rs 60 in six months’ time. What this means that the basket of shares in your scheme has appreciated by 20 per cent. The daily changes in NAV mutual fund calculation represents the price changes of the shares in your mutual fund portfolio.

The same applies to net asset value calculation in debt fund schemes as well. NAVs of debt schemes also keep changing, because of changes in interest rates and the profits fund managers make by selling and buying fixed income instruments like bonds and debentures. But the daily changes in NAVs are not so dramatic as in equity funds.

An easy way to check returns

Mutual fund NAV calculation make it easy to check the returns you make on your investments. You can track returns on an everyday basis, monthly or even quarterly. Of course, checking NAVs every day is not necessary since you have to hold mutual funds for a while before you can make returns. But investment experts recommend that investors check mutual funds NAVs on a quarterly basis to find out how their schemes are doing. You can also do it if you are planning to change your investment plan and rejig your portfolio. Another good time to check your NAVs is when there’s a major event, like a bull run on the stock market, a crash, or a change in interest rates that will affect NAVs of your debt funds.

Timing and NAVs

The time at which you invest in scheme will have an effect on NAV mutual fund calculation. If you invest before 3 PM on a working day, you will be able to get the same day’s NAV. But if you purchase after 3 PM, you will get the subsequent day’s NAV for your mutual fund units. The same goes for NAV calculation when you are redeeming funds. So if NAVs are changing, you will probably save some money if you get the timing right. Of course, this will make a difference only if you are investing large sums of money.

What NAVs miss out

Mutual fund NAV calculation helps you find out how a scheme is doing. However, NAVs don’t not tell you how the underlying assets of the fund are faring. For example, they will not tell you that the shares in your schemes have very high price-earnings ratios and thus overvalued. The future performance of such schemes could therefore be in doubt.

In the case of a debt fund net asset value calculation, you may not get an idea of the quality of the instruments the fund manager is investing in by just looking at the mutual fund NAV. In short, while a mutual fund NAV is a good indicator of fund performance, it is by no means the only parameter you should be looking at. Remember the old catchword: Caveat emptor or buyer beware!

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