Invest in the mutual fund, not its NAV

Invest in the mutual fund, not its NAV

NFOs (New Fund Offers) launched at an issue price of Rs. 10 are perceived to be a good investment opportunity by a large section of mutual fund investors. Similarly, existing mutual funds with a lower NAV (Net Asset Value) often appeal more to investors. We believe that that neither of the approaches to selecting a mutual fund is right. In this note, we revisit our views on investing based on the NAV.

Mathematically NAV is expressed as:

NAV (Always expressed per scheme) = Total of all assets – less liabilities (other than to unitholders)

                                          Total number of outstanding units

An illustration should help to understand better how the NAV is calculated:

NAV calculation

Total Assets (in Rs.):       71,000
Liabilities (in Rs.):              1,000
No. of Units:                      5,000
NAV (in Rs.):                         14

So, when an investor invests in a mutual fund, he invests at its existing NAV. The investor buys the units at a price (i.e. NAV), the calculation of which is based on the current market price of all the assets that the mutual fund owns. In other words, the NAV represents the fund’s intrinsic worth. In case of the stock market investing however, the stock price of a company is usually different from its intrinsic worth, or what is called the book value of the share. The stock price could be higher (premium) or lower (discount) as compared to the book value of the company. A relatively lowershare price would, other things being positive, make it an attractive purchase (as the share seems undervalued).

The reason for such a ‘mis-pricing’ could be that investors evaluate the company’s future profitability and suitably pay a higher or lower price as compared to its book value. This does not hold true for open-ended mutual funds – they always, always, trade at their book value; so investors never buy them cheap or expensive in that sense.

The following illustration will clearly establish the irrelevance of NAV while making an investment decision.

NAV: Does it matter?

Open-ended large cap equity funds                      NAV (Rs.)          1-Yr (%)
HDFC Top 200 (G)                                             224.76               30.9
Franklin India Prima Plus (G)                                233.99               30.0
Franklin India Bluechip (G)                                   224.53               29.2
ICICI Pru Power (G)                                           121.69               28.3
Principal Large Cap (G)                                         30.65               28.1
SBI Magnum Equity (D)                                         35.04              27.2
ICICI Pru Target Returns (G)                                 14.98              26.4
                                                                              (Source: ACE MF)

                                                             NAV and Performance as on Sept. 30, 2010.

HDFC Top 200 Fund, with an NAV of Rs. 224.76 (second highest NAV in our sample) has topped on the 1-Yr return front, by clocking a return of 30.9%. On the other hand, Franklin India Prima plus Fund which tops on the NAV front ( Rs. 233.99) has clocked a return of 30.0%. Hence, it clearly indicates that there is no correlation between the NAV and the performance of the mutual fund. This makes an investment decision based on the NAV potentially misguiding. As an investor, you need to consider factors such as your own risk profile, the fund house’s management style and the mutual fund’s performance.