Does a Low/High NAV of mutual fund determine its performance?
The Net Asset Value (NAV) of a mutual fund is the price at which units of a mutual fund are traded in the market.It is the market value of the fund after deducting its liabilities. In simpler words, NAV is the price per unit of the fund, just like any share has a price.
The NAV of a mutual fund will be calculated on a daily basis. The total value of the mutual fund portfolio is calculated on a daily basis, from which all expenses are then deducted. The result is then divided by the total number of units which gives the NAV for that fund.
NAV (Net Asset Value) = (Asset- Debts) / (Number of outstanding units)
Assets = Market value of mutual fund investments + Receivables + Accrued Income
Debts = Liabilities + Expenses (accrued)
While deciding on which fund to invest, an investor will definitely compare the NAV of different funds which she is considering to invest. The following are the common myths usually an investor has while comparing the NAV of the funds she is planning to invest in.
Myth 1-Lower NAV gives higher number of units which can give higher returns on investments
Many investors who come to us for investments ask the question – ‘Does the NAV have any role in the returns of a fund?’ The answer is ”NO”. The NAV does not have any role in the returns of the fund while the returns is influenced purely by the performance of the shares in the fund. The below illustration clearly shows that the NAV does not have any role in the returns of the fund.
Myth 2– The NAV of Dividend option is less than the NAV of Growth option of the same fund, so better to go for Dividend option rather than the Growth option.
This is a general question that our investors usually ask us – ‘Should I go for a dividend reinvestment option or a growth option as the NAV of the dividend option is less than the growth?’ The answer is that there is no effect on your returns in both the options, while if you are going for long term then the growth option is better. The following illustration helps to understand the effect of NAV in a Growth and Dividend re-investment option.
In reality, the fund house has to deduct a Dividend Distribution Tax (DDT) on the dividend before declaring the dividend. This can create a small drop in the returns of investment in a long term perspective, if the investor had opted for the dividend reinvestment option.
Myth 3- Lower NAV gives higher number of units, which can give higher dividend
Lot of investors who want regular income from their investments ask us this question frequently, especially the retired population. We should keep in our mind that the money a mutual fund distributes as dividends is our own money and the NAV of the fund does not affect the dividend of the fund.
Myth 4- The funds with higher NAV have reached their potential growth and are on high valuations
This is a general myth that most of the investors have when we talk about a good fund with a higher NAV, they tend to oppose that the fund is on a higher NAV and the fund has already reached its potential growth. We should understand that a fund comprises of a portfolio of different stocks from different sectors which are managed by highly qualified team fund managers. The fund manager invests in a particular share looking upon the future potential of the share which will suit with the investment objective of the fund. The fund manager purchases the share on a long term perspective with a specific investment objective.
Once the share attains the fund manager’s investment objective, the fund manager sells that share and look forward for other shares for the investment. The fund managing team hunts for less valuation shares with strong fundamentals to grow which makes it difficult to calculate the valuation of the fund at any specific point of time.
So, the NAV of the fund does not replicate the potential of the fund nor does it indicate the potential growth of the fund.
Myth 5-New Fund Offers (NFO) with the lower NAV are better than the existing fund with higher NAV
When New Fund Offers (NFO) are declared, we usually see that our existing investors come with a request to redeem the current holdings and invest in NFO’s with same fund objective. The usual reason given is that they are getting the fund with same investment objective on lower NAV.
But, does it really matter? No. For eg:- If both the funds hold same or similar portfolio, then the returns from the portfolio will have the same effect on the returns of both the funds. So investing in an NFO instead of an existing fund because of lower NAV gives no advantage.
This showsthat the NAV should not be a deciding factor on purchasing of a fund. Investing in a low NAV or high NAV fund does not make any difference in the performance of the fund.
While selecting a new fund for investments, the investor can look for the following points which will influence the performance of the fund.
1) The stocks and the sectors in which the fund invests
The performance of the fund can be directly influenced by the performance of the stocks and the sectors to which the fund is exposed to. Any change in the political or economic factors which influence a particular stock or sector can reflect on the fund’s performance depending on its holding towards it. The future performance of the fund can be analysed depending up on the future performance of the sector or stocks that the fund holds.
2) Sector concentration
The sector concentration also affects the fund performance. If the fund is more concentrated towards a particular performing sector, then the performance of that sector will affect the performance of the fund. This will also increase the risk pertaining to that particular sector on the fund. It is better to have a moderate concentration on the top 10 sectors the fund is exposed to.
3) Frequency of Fund rebalancing or fund turn over.
The fund management team selects the best stocks in the initial stages of the fund, when the circumstances and the strategies of the fund changes the fund management team reshuffle or rebalance the fund. The frequency of fund rebalancing can affect the performance of the fund in both the ways. In a positive way, the frequent rebalancing helps to exploit the opportunities in the prevailing market, while in a negative way, it can increase the expenses of the fund.These changes will impact fund prices for the better or for worse depending on the action taken.
4) Expense ratio
The expense ratio is a silent killer which eats the return of your funds in a long term. The funds with higher expense ratio have to spend more money on fund expenses which will impact the profit from portfolio. The expense ratio of a fund will be determined by different factors like portfolio turnover, AUM size etc. As the portfolio turnover increases, the expense ratio of the fund also.
increases, while the increase in the AUM will help in reduction of expense per unit.
5) Cash flow towards the fund
The popularity of the fund has certain influence on the performance of the fund. The popularity of the fund helps to increase the cash flow towards the fund. This will give the fund manager the liberty to buy stocks which he thinks have future growth potential. The fund’s cash flow also helps to maintain a consistency in the fund’s portfolio. If the fund is not performing well, then there will be a cash out flow in the fund which will force the manager to sell the holdings which will affect the performance of the fund in a very bad way.
So this comes to the conclusion that either the NAV be High or low of the fund, its impact on the performance of the fund is comparatively very low.ow, we have discussed some of quantitative factors that influence the performance of the fund. There are some qualitative factors like the experience of the fund manager, life span of the fund, changes of fund house leadership etc. which also need to be checked while selecting a fund.
Content Strategist Dilzer Consultants Pvt Ltd
10 Nov 2017