NAV Myth – Are you falling for the trap?

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Does Net Asset Value (NAV) of mutual funds matter? Many investors believe it does matter. Yesterday, we had a conversation with a prospective client and we recommended some schemes which we believed were suitable for his investment objectives. The next question he asked was “What is the NAV of the scheme?”

This is not the first time a prospective client asked this question. And every-time someone asks this question, our answer is “We don’t know”. Rather we don’t care to know.

Why some people ask for NAV? When counter questioned, they said that lower NAV will grow faster whereas a higher NAV has lower growth prospects as it has already gone up. Hmm… Really! We totally disagree as it is devoid of any logic and reason.

Let us go to the basics and try to understand why NAV value doesn’t matter. NAV is calculated by dividing total assets under management (AUM) of the mutual fund scheme by number of outstanding units.

NAV = Total AUM/No of Outstanding Units

So that means if total AUM (or corpus) of a scheme is INR 100 crores, and number of units are 10 crores, the NAV of the scheme is INR 10 (100crore/10crore).

Now let’s take an example of two schemes – Scheme A with NAV of INR 10 and AUM of INR 10 Crores and another Scheme B with NAV of INR 100 and AUM of INR 1,000 Crores. And let us assume you invested INR 1 lakh in both the schemes. In Scheme A, you invested at NAV of INR 10 and got 10,000 units. In Scheme B, you invested at INR 100 and got 1,000 units.

For the sake of easy comparison let us also assume that both Schemes A and B invests their AUM in only four stocks (HDFC Bank, Tata Motors, Sun Pharma and Hero Motocorp)  in equal proportion that is 25% each.

We assigned random growth rates for the underlying stocks where both the schemes invested their AUM as shown below:

nav
Therefore, investment in any scheme (A or B) irrespective of NAV value generated returns of 6% on the investment value. Return on investment value is the function of changes in the underlying stocks in which the AUM is invested and not on NAV in any case. Generally older the scheme, higher is the NAV and vice versa. Both new and old schemes will invest only in available universe of stocks trading at prices similar for both the schemes.As we can see in above table, Scheme A’s AUM increased to INR 10.60 crores and Scheme B’s AUM increased to INR 1,060 crores. Since total outstanding units have not changed in respective schemes, the NAV of Scheme A increased to INR 10.60 and the NAV of Scheme B increased to INR 106. Your INR 1 lakh investment in Scheme A becomes INR 106,000 (10.6 NAV x 10,000 units) which is same as in Scheme B (106 NAV x 1000 units).

Well to be fair, this is not completely the mistake of the investor. This is a popular myth spread by few mutual fund companies and some agents to sell NFOs which are launched at NAV of INR 10. As NFOs (which are a medium to raise more funds for mutual fund companies and to make higher commission for agents) have no track record of past performance to show, low NAV becomes easier but misleading bate to sell them.

While selecting a scheme for investment, comparison of past performance of the schemes in the same category, investment processes of the fund house, investment philosophy and style of fund manager along with portfolio attributes should be the criteria after taking into account the investment objectives of the investor.

We hope, through this article we were able to burst the NAV myth. We would be happy to receive your feedback in the comment section below.
Please Note: This is a financial education initiative by Truemind Capital Services to promote investment literacy among the masses. Truemind Capital Services is a SEBI Registered Investment Adviser and operates www.truemindcapital.com for investments in mutual funds. Please refer Disclaimer in Terms & Conditions at www.truemindcapital.com/terms&conditions  You agree to accept and abide by terms & conditions if you take any decision based on the content in the above article.

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