Does NAV of mutual fund really matter?
Mar 28, 2011

Author: PersonalFN Content & Research Team

Before buying anything, we all have a tendency to check the price of that particular product. Be it household items, apparels or even stocks. And to get the best deal possible we also do bargain. Don’t we? Unfortunately this tendency of checking the price (NAV) has also creped into many of you investors while investing in mutual funds. But have you thought - does that really matter while investing in mutual funds?

 

Checking a fund’s NAV before investing is absolutely a futile and a baseless exercise, in our opinion.

 

Well you may not believe it instantly; as the habit of first checking the price of a product runs in your nervous system. It always plays on your minds that lesser the NAV, the cheaper the mutual fund scheme.

 

Even in case when an New Fund Offer (NFO) hits the market, a large section (going by the “habit”) of you investors rush into investing in the fund without even assessing what is its mandate, where and how would it invest the corpus collected and whether does it really suits your risk profile. This is because the offer price of 10 excites you. Similarly, when an existing mutual fund scheme’s NAV is low, you all tend to again perceiving it to be a buying opportunity.

 

But please recognise that, the approach of investing in mutual funds by judging its price – the NAV, cannot be followed just as the same manner while investing in stocks. This is because when you invest in a mutual fund, you buy units at its NAV. Thus you buy 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.

 

However in case of the stock market investing, 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 lower share 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 you 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 you never buy them cheap or expensive in that sense.

 

Remember, increase or decrease in the NAV of a mutual fund scheme is a function of how well the fund manager makes his investments bets in the market as well as how long the fund has been in the industry.

 

The illustration present in the table below will also clearly help you establish the irrelevance of NAV while making an investment decision.

 

NAV: Does it matter?

NAV ( ) 3-Yr (%)
HDFC Equity (G) 275.36 18.4
HDFC Top 200 (G) 209.07 16.1
ICICI Pru Dynamic (G) 107.01 14.3
Sundaram Select Midcap (G) 142.25 13.7
UTI Mid Cap (G) 30.15 12.7
Religare Mid Cap (G) 13.42 7.6
Morgan Stanley Growth (G) 58.94 6.0
JM Mid Cap (G) 22.69 5.7

NAV and Performance as on March 25, 2011.
(Source: ACE MF, PersonalFN Research)

 

HDFC Equity Fund with an NAV of 275.36 has topped on the 3-Yr return front, by clocking a return of 18.4% CAGR. On the other hand, Religare Mid cap fund which has the least NAV ( 13.42) has clocked a return of mere 7.6% CAGR.

 

So, please recognise that NAV’s are an irrelevant when selecting winning mutual funds for your portfolio. A lot of qualitative and quantitative factors have to be thoroughly analysed before zeroing down on any mutual fund scheme. 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.

 
  1. Risk profile

    Every investor has a risk profile that dictates how much risk they can take on to achieve their investment objective. In this backdrop, you must identify mutual funds that can help you meet your investment objectives at the desired risk level. For instance, some equity funds adhere to the growth style of investment (aggressively managed funds); while others follow the value style of investment (conservatively managed funds). So, it is important for you to select a mutual fund scheme that takes on risk in line with your own risk appetite.
     
  2. Fund management style

    Fund houses have varying fund management styles and processes. Some pursue the individualistic style, where the fund manager has his own style of investing, rather than the preset investment process fixed by the mutual fund house.

    As opposed to this, there are mutual fund houses that pursue a team-based investment approach where the investment process and system holds influence over the individual. Your preference should be for the team-based process driven approach of investing, since it is more stable and the mutual fund (and its investors) is not over-dependent on an individual.
     
  3. Mutual fund performance

    It is imperative for you to evaluate a mutual fund schemes beyond returns, by taking into account parameters such as the risk of the fund (as denoted by Standard Deviation), risk-adjusted returns (as denoted by Sharpe Ratio), portfolio concentration, experience of the fund manager and host of other research factors. The best deal for an investor will come from a mutual fund that has higher NAV appreciation and Sharpe Ratio and lower Standard Deviation.
     

Hopefully, now we believe that we have resolved the debate on the NAV and have given you more relevant points to inquire about before considering investing in a mutual fund. So, the next time your mutual fund distributor advances the low NAV or 10 NAV arguments, demand a detailed analysis of the mutual fund based on the parameters we have listed. Remember there’s more to selecting winning mutual funds than just the NAV.



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Comments
joshiravindr@gmail.com
Apr 07, 2011

a casual look at table displaying NAV with 3years% return, it is obvious that those funds hving higher NAV have given higher returns than those with lower returns exactly in descending order.
              so why you are saying "NAV’s are an irrelevant when selecting winning mutual funds for your portfolio, while table displayed conveys exactly opposite
research@personalfn.com
Apr 08, 2011

Dear Mr. Nagendra,

If you read the article well, what you are trying to say is exactly our point of view.

Remember, we are saying that in fact many of you investors look out for cheaper bargains by selecting funds with lower NAVs, but often forget that the exercise of selecting winning mutual funds is not as the same while undertaing stock picking because the fund's NAV represents its intrinsic value.

We aren't even mentioning that you investors should time the market; because mutual funds per se as a product is a "long-term investment instrument". However, in order to even out the volatility of the equity markets and to bend it your advantage, we  recommend all you investors to adopt the SIP route while investing in mutual funds, in order for you to benefit from rupee-cost averaging and compounding.
research@personalfn.com
Apr 08, 2011

Dear Mr. Ravindra,

A lot of you investors are in the fancy of bargaining and are rather price sensitive while buying mutual funds. You tend to look at the NAV of the fund before investing (just as you do in stock picking) and look at the ones with cheaper NAVs.

But in this bargain you forget to recognise the fact that in case of the mutual funds the NAV reflects the fund's intrinsic value (which need not be in case of stock , as they are driven by several fundamental factors as well as behavioural finance aspects impacting stocks).

Our objective here was to highlight exactly that, and we have explicitly mentioned the same if you read the article well.  We are saying looking at cheaper NAV funds need not always give you enticing returns. 
nagendra.korlipara@yahoo.com
Apr 08, 2011

You are telling only part of the story.

NAV is as relevant as the price of a share as the NAV is calculated based on the prices of the shares that the scheme holds.Afund with a higher NAV tells us that it is performing well in comparison to a fund with lower NAV.

The first part of the story is selecting a good fund.

The Role of NAV starts once the you have selcted a fund for investment.HDFC Equity(GR) fund's NAV is Rs.275.31.So one will be better off if he can buy the same at Rs.260.00 or 240.00.So you do not know when you will be able to buy it at a lowe price.

So the system of Systematic Investment has comes into existence,to enble you to buy at different NAV's so that the average price is not high or low.

What you have to advise is ;to ignore funds with NAV of Rs.10.00 or below Rs.10.00.The Rs.10.00 fund has no performance to show, and the fund with NAV lower than Rs.10.00has established that its performance is bad.

K.M.NAGENDRA

Apr 08, 2011

Ravindra,

If you read the article carefully, you can get some indications about the reasons why those funds are giving high CAGR. Certainly not because of their high NAVs.
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