Investors tend to question whether a lower Net Asset Value (NAV) mutual fund is a bargain or a better investment choice. In this article, we discuss the meaning of NAV, dispel popular myths, and describe why lower NAVs are not always reflected in better returns.
What is NAV?
Net Asset Value (NAV) is the unit price of a mutual fund determined by dividing the total value of the fund’s assets minus liabilities by the number of units outstanding. It is adjusted daily in response to changes in the market. NAV assists investors in determining the value of their investment, but it should be mentioned that it is an accounting number and not a direct measure of performance.
It’s calculated using the formula:
NAV = (Total Assets – Total Liabilities) / Total Outstanding Units
This number represents the market value of each unit in the fund and fluctuates daily based on the performance of the fund’s underlying assets.
Key Points:
- NAV Is Simply a Price: A fund’s NAV is comparable to the price of a share of stock; it’s the current unit price and doesn’t necessarily reflect whether the fund is a good or bad investment.
- Various Funds, Various Scales: Mutual funds may have extremely different NAVs based on their history, asset sizes, and even historical dividend payouts.
Debunking the Myth: Lower NAV Means Better Returns?
A mistake many first-time investors make is assuming that a lower NAV is a “cheaper” mutual fund, and thus it will provide higher returns. The absolute number of the NAV does not matter in relation to the percentage returns you will get.
Why Lower NAVs Don’t Guarantee Better Returns:
- Arbitrary Unit Pricing: NAV is determined from the total liabilities and assets of the fund and then divided by the units. Fund houses can arbitrarily fix their initial NAVs at the time of launch (e.g., ₹10, ₹100, or ₹1,000). A lower starting NAV does not indicate that the fund is underpriced.
- Return Measurement: The returns are recorded in terms of percentage gain, irrespective of the NAV amount. For instance, if Fund A’s NAV has risen from ₹10 to ₹15, it is a 50% gain; if Fund B’s NAV has risen from ₹100 to ₹150, the 50% gain percentage is also achieved.
- Fund Performance Drivers: The performance of a fund rests on the merits of the fund’s investment, market condition, expertise of fund managers, and strategy—and not on its then-current NAV.
- Investor Focus: Rather than looking at the NAV, investors need to consider the fund’s historical returns, risk-adjusted performance, expense ratios, and long-term consistency.
Key Factors to Consider When Evaluating Mutual Fund Returns
Instead of the NAV, take into account these considerations to find out the potential of a mutual fund:
1. Historical Performance and CAGR
- Historical Returns: Examine the performance of the fund across different time periods (1-year, 3-year, 5-year CAGR).
- Consistency: Consistent performance across different market cycles is a good indicator of a reliable fund.
2. Expense Ratio
- Cost Efficiency: Lower expense ratios can improve net returns over time. High fees can erode the benefits of a fund’s gains.
3. Risk-Adjusted Returns
- Sharpe Ratio and Standard Deviation: These metrics help you understand the level of risk taken to achieve the returns.
- Risk Tolerance: Align the fund’s risk profile with your own investment goals.
4. Fund Manager’s Expertise
- Experience: A seasoned fund manager with a proven track record can add significant value.
- Investment Strategy: Evaluate if the fund’s strategy aligns with your financial objectives.
5. Investment Horizon and Goals
- Long-Term vs. Short-Term: Select a fund depending on your investment horizon. For long-term objectives, aim for funds that have steady, consistent returns and not for short-term gains.
Case Study: Comparing Two Hypothetical Funds
Consider two funds:
- Fund A: Starts with an NAV of ₹10 and grows to ₹15 over one year (a 50% gain).
- Fund B: Starts with an NAV of ₹100 and grows to ₹150 over the same period (also a 50% gain).
Although Fund A’s NAV is lower, both the funds have yielded the same percentage returns. Performance is gauged by the percentage rise and not the absolute value of NAV.
So, Do Lower NAVs Give Better Returns?
The short answer is no. A lower NAV does not necessarily mean a mutual fund will perform better. The NAV is merely a snapshot of the per-unit price at a particular moment. What actually counts is:
- The growth in NAV over time
- The fund’s overall performance metrics
- How well the fund’s investment strategy is executed
Tips for Investors
- Focus on the Bigger Picture: Look at the total return and consistency of the fund, rather than fixating on a low unit price.
- Compare Similar Funds: Evaluate funds within the same category, as they are more comparable in terms of strategy and risk.
- Review Regularly: Keep an eye on the fund’s performance reports and updates to ensure it continues to align with your goals.
Conclusion
The idea that lower NAVs correspondingly provide improved returns is a fallacy. NAV is simply an indicator of the per-unit worth of a mutual fund and does not reflect quality or probable returns directly.
Use key performance indicators such as past returns, expense ratios, risk-adjusted performance, and the qualification level of the fund management team for informed decision-making.
Remember: Always conduct thorough research and consult with a financial advisor before making investment decisions. Mutual fund investments should align with your individual financial goals and risk tolerance.
Frequently Asked Questions (FAQ)
What does a low NAV indicate?
A low NAV simply means the current per-unit value of the fund is low. It does not automatically suggest the fund is undervalued or that it will generate higher returns.
How can I measure a mutual fund’s performance effectively?
Focus on metrics such as the fund’s annualized return, 5-year CAGR, expense ratio, and risk-adjusted performance indicators like the Sharpe ratio.
Should I choose a mutual fund based on its NAV alone?
No. Choosing a fund solely based on its NAV ignores other critical factors such as past performance, management quality, and overall investment strategy.
Are there any benefits to investing in funds with lower NAVs?
Funds with lower NAVs can sometimes offer easier entry points, especially if you are investing a fixed amount regularly through SIPs. However, the investment decision should be based on overall performance and suitability.
