Mutaul Fund NAVs and size does not matter

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The saying "size does not matter" goes well with net asset values (NAVs) in the mutual fund (MF) space. There are several aspects of MFs which are misunderstood by investors — the magnitude of the NAV of an MF scheme is one of them.

Some investors believe that lower the NAV, the cheaper it is. Hence, in turn, the fund is equipped to deliver better returns vis-à-vis a fund with a higher NAV. Before we debunk this myth, let's first understand what the NAV is and how it is calculated.

Simply put, the NAV is the value of each unit of an MF. It is calculated as the net assets of the fund (assets less expenses) divided by the number of units. A hypothetical example will help us better understand this.

Say, a fund's total assets amount to Rs 4.10 lakh and expenses chargeable to the fund amount to Rs 10,000. Assume that the number of units issued is 20,000. This results in an NAV of Rs 20 per unit, that is (Rs 4.10 lakh less Rs 10,000) divided by 20,000.

In other words, the NAV of an MF scheme represents the intrinsic value of each unit of the scheme.

NAV is not the same as a stock price

Now that the concept of NAV has been explained, we can address the misconception that a lower NAV is always cheaper and better than a higher one. Often, investors make the mistake of drawing a parallel between an MF's NAV and a company's stock price.

In the case of a stock, the book value (which is representative of its intrinsic value) can be distinct from the market price (determined by demand and supply factors). Hence, the concept of a cheaper or an expensive stock.

However, as we have discussed earlier, in an MF the NAV represents the asset value underlying each unit, which is the intrinsic value of each unit.

Hence unlike stocks, there is no divorced intrinsic value and market price.

Of course, over the years the 'lower NAV equals a cheaper buy' myth has been put to good use by several fund houses and distributors. This was particularly apparent in the case of new fund offers (NFOs). Several investors became victims of misselling since they were led to believe that the Rs 10 NAV in an NFO amounts to making a cheaper buy.

Lower NAV and performance

Now let's find out if a lower NAV has necessarily helped funds deliver better returns or for that matter if a larger NAV has been a detriment to performance.

Let's consider the growth option NAVs of some funds.

In April 2007, Scheme A had an NAV of Rs 111.8. In the subsequent three-year period, the fund posted a growth of 18.9% on a compounded annualized basis. On the other hand, Scheme B with a substantially lower NAV (Rs 11.7) grew by just 8.5% on a compounded annualized basis.

Clearly, the higher NAV didn't stop the fund from pitching in a better performance than a fund with a lower NAV. So does that mean that a higher NAV is always better? No, even that is not always true. For example, scheme C, with an NAV of Rs 12.4 in April 2007, outscored several funds with higher NAVs and delivered a growth of 16.6% on a compounded annualized basis.

Investors must therefore understand that a fund's NAV has no bearing on its performance. The performance is determined by factors like the fund manager's skills, the investment processes and style, among others.

The NAV is irrelevant while making investment decisions. A lower or higher NAV doesn't make a fund an attractive or unattractive one, and vice-versa.

The NAV size simply doesn't matter while deciding which mutual fund scheme to invest in.

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