Net Asset Value (NAV) is arguably the most popular term when it comes to mutual fund, for a multitude of reasons. However, what is it, and what does it do to your portfolio? Interestingly, does NAV increase/decrease necessarily reflect whether, in fact, capital is being increased/decreased? Performance sensitivity to NAV is by far the key factor in assessing the success of the investments made in the investment group assets of your investment pool.

What is NAV?

NAV stands for Net Asset Value, which is the unit price of a mutual fund, i.e., Price of Units. It is an estimate of the ratio of the weighted sum of all the fund’s fractions of assets (i.e., stocks, bonds, cash) to fund liabilities divided by the number of fund units owned by the investors.

The formula for NAV is:

NAV (Total Assets – Total Liabilities) / Total Units Outstanding.

E.g., if the amount of the mutual fund is ₹100 Crore and its liabilities are 5 Crore and it has 10 lacs units, respectively, the NAV will be:

NAV = (₹100 Crore – ₹5 Crore) / 10,00,000 = ₹95/unit.

How NAV Changes?

The net asset value (NAV) is computed daily on the basis of the depressed prices of the fund’s assets. Factors influencing NAV include:

Market Performance: If the fund’s assets perform well, NAV increases. Conversely, poor performance leads to a decline in NAV.

Dividends and Distributions: When a mutual fund makes capital distributions (i.e., dividends) to its investors the mutual fund’s Net Asset Value (NAV) is reduced as capital distributions decrease the total assets in the mutual fund.

New Investments and Redemptions: Through an investor’s buy or a unit holder’s declaration of units, the number of units in the market hands change, yet it does change the NAV per unit in some significant way.

Does a Higher NAV Mean Better Performance?

This is a common misconception among investors. It is by no means logical to suspect that higher NAV fund is a good fund, and conversely, that NAV fund with a lower NAV is a less good fund. NAV is only presented how much the current Unit of fund is currently worth but not presented the future growth or performances’ result of historic.

For example, Fund A has a net asset value (NAV) of ₹50 and Fund B has an NAV of ₹500. As both funds are growing by 10%, your investment will grow at the rate of 10%, but the NAV is not growing at the rate of 10%. Rather than these figures, it is the growth rate, and not this NAV value per se, that should be considered.

Is Your Money Really Growing?

The investment outcome itself depends not only on the fund returns but also on the returns that take fund NAV value outside of it. To evaluate if your money is growing:

Check Historical Returns: Contrast the fund’s 1 year, 3 years and 5-year average annualised returns (i.e. returns actually given in these time periods)

Compare with Benchmarks: Identify the average performance of the fund in relation to its benchmark index (Nifty 50, Sensex) to ascertain if any superior performance of the fund is being achieved.

Key Points to Keep in Mind

Initial NAV is Irrelevant: All schemes carried an NAV of ₹10 as of launch of schemes (time wise). The historical behaviour of the fund, i.e., its returns (and hence NAV) rather than the (current) NAV determines its performance.

Systematic Investment Plans (SIPs): With SIPs you purchase a higher number of units if NAV is low and a lower number if NAV is high, and do so via cost averaging over the long run. This is called Rupee Cost Averaging.

Long-Term Perspective: NAV fluctuations in the short term should not distract you. Focus on the fund’s consistency and long-term growth.

Conclusion

Net Asset Value (NAV) is one of the main metrics with which the price of the unit in a mutual fund is to be priced, but NAV is not a measure of investment return. Growth originates from both fund performance and the perceived soundness of fund returns and your financial goal.

As for any investment it is, no doubt, useful to see the history of the fund, the expense ratio and the composition of the portfolio in order to ensure the fund is still “good” (i.e. in line with) your appetite of risk and with your investment targets. That is to say, successful investing is not simply a matter of numbers on a wall, but of preparing.