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Net Asset Value

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.

What is NAV?

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 price – generally Rs 10. After it gathers the funds, the fund house then invests them in the avenues defined by the investment objectives.

After the collected funds are invested in, say, stocks, the scheme arrives at the mutual fund NAV, which is determined by the prices of the shares minus 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.

The fund will declare the mutual fund 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). In the case of a close-ended fund, the scheme is listed on the stock exchange 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, the 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. 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. The NAV may be low 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 their 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.

Mutual fund NAVs are used to gauge the value of units. Suppose you have purchased units of a certain scheme at a mutual fund 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 percent. The daily changes in the NAV represent the price changes of the shares in your mutual fund portfolio.

The same applies to debt fund schemes as well. Mutual fund 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 mutual fund NAVs are not so dramatic as in equity funds.

An easy way to check returns

Mutual fund NAVs are an easy way of checking the returns you make on your investments. You can track returns on an everyday basis, monthly or even quarterly. Of course, checking mutual fund 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 mutual fund 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 alter the NAVs of your debt funds.

Timing and NAVs

The time at which you invest in the mutual fund scheme will have an effect on NAV. 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 redemption. 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 NAVs are a good way of finding out how a scheme is doing. However, they don’t tell you how the underlying assets of the fund are faring. For example, it will not tell you that the shares in your scheme have very high price-earnings ratios and thus overvalued. The future performance of such a scheme could, therefore, be in doubt.

In the case of a debt fund, 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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