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Why you should not look at mutual fund NAVs while investing

May 08, 2019 by Anirudh Dar

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Net Asset Value (NAV) is the price at which units of mutual fund schemes are bought or sold. Mutual fund NAVs are calculated daily based on the daily closing prices of the underlying securities in portfolios of individual mutual fund schemes after making appropriate adjustments for the scheme’s expenses. AMCs incur expenses for the services provided like fund management, administration, distribution etc. and they charge for these expenses proportionately to the assets of schemes. The expenses are netted off in the price of the units and the NAV of a mutual fund scheme is net of expenses.

Read in detail what is NAV of Mutual Fund

Many equity investors look at mutual fund NAVs in the same way as they look at stock prices, but there are major differences between the two. An important difference between a mutual fund and stock is that a unit of mutual fund by itself has no value; mutual funds derive their value from underlying stocks. While the price of a stock depends on the demand and supply of the stock in the market, the NAV of a mutual fund does not depend on the demand and supply of the scheme. It depends in the value of the portfolio of securities of the scheme.

High or low prices may make a stock expensive (over-valued) or cheap (under-valued). However, mutual fund schemes with higher NAVs are not necessarily expensive and schemes with lower NAVs are not necessarily cheap. Mutual fund schemes are launched at par value (Rs 10) and the current NAV reflects the growth in the asset value since inception of the scheme. Older mutual fund schemes may have higher NAVs while newer mutual fund schemes may have lower NAVs. This does not make the older schemes expensive or the newer mutual fund schemes cheap.

A newer scheme may buy expensive (over-valued) stocks and still have lower NAV compared to an older scheme which buys cheap (undervalued) stocks. The NAV of a mutual fund scheme, by itself, is not very useful to make investment decisions.

Some investors think New Fund Offers (NFO) is attractive because they are available at par value (Rs 10). As mentioned earlier, the par value of a mutual fund unit is derived from the value of the underlying securities and the accumulated profits since inception. Two different mutual fund schemes may have exactly the same portfolio of securities and yet one scheme may be offered at par value which is generally Rs 10 NAV, while the older scheme NAV might be more than Rs 100; the difference in price notwithstanding the intrinsic value of both the schemes is exactly the same. The compounded annualized growth in NAV over a period of time versus the scheme benchmark is the relevant measure of mutual fund performance.

Check historical NAV of a mutual fund scheme

Furthermore, one should not compare NFO and IPO because there pricing mechanism is very different. As discussed earlier, NFO is priced at par value but the NAV itself does not imply attractiveness or lack of it. The NAV of mutual fund scheme whether NFO or old is basically a per unit price, based on the market value of the total assets and the number of units outstanding. IPOs are priced using a different mechanism and often we see listing gains for investors, when the market price of the shares on the listing day is higher than the share price. There can be listing losses in an IPO as well, if the share price after listing is lower than market price. However, there is no such thing as listing gain or loss in an NFO; the NAV of the scheme will depend on the market price of all the securities in its portfolio.

Investors often book profits in stocks which see considerable price appreciation in the hope of an impending price correction. Buying low and selling high is one the fundamental tenets of equity investing, but the same does not apply in mutual funds. You should remember that an equity mutual fund is essentially a collection of stocks, and therefore, the price behaviour of a mutual fund will be very different from price behaviour of individual stocks. Mutual funds, unlike stocks, offer risk diversification and should be purely for investment purposes over a long investment horizon. Funds which have performed well, on a risk adjusted returns basis, are likely to perform well in the future also.

Did you know what are the benefits of investing in mutual funds versus directly in shares

Conclusion

In this article, we discussed some mutual fund NAV myths. Mutual fund investments should not be based on fund NAVs. You should select funds for investments based on your financial goals, risk capacity and the fund manager’s track record. By following a structured financial plan instead of a price based tactical approach, you will be able to get far better results.

Suggested reading: which is the best mutual fund according to your risk appetite?