Does a high or low NAV indicate future performance of a Fund?

Author: Nikhil Kothari, Research Analyst, iFAST Financial India Pvt. Ltd.

We highlight that current NAV of a scheme whether high or low should not be a determining

factor for purchasing a fund.

Novice investors are often confused with the term Net Asset Value (NAV) as it may become difficult to

judge whether they should be buying a fund with higher or lower NAV. Then, what should one be

checking?

NAV simplified

Basically, NAV is the price at which investor buys or sells units of Mutual Fund. It is derived by dividing

the total assets (sum of total value of all securities and cash) of the fund by the number of units issued

to investors. The value of your investment is driven not only by NAV but, it is a product of NAV and

number of units.

We explain why comparing the fund NAV is actually a futile effort for the investor.

Myth busting

Myth I: An investor has a misconception that a fund with higher NAV will give fewer units. Though this

is true, it is not the correct criteria to select a fund.

Let us understand this with an example: Suppose, Fund A has a NAV of INR 100 and there is another

fund B with NAV of INR 20. An investor puts INR 1,00,000 in both the funds so accordingly, he will

receive Rs 1000 units of Fund A and 5000 units of Fund B ( Investment value / NAV = Number of Units).

Now, assume that return generated by both the funds is 20% in a year’s time. Therefore, NAV of Fund A

and Fund B after a year would be INR 120 and INR 24.

If we calculate the value of the portfolio for both the funds, the value of Fund A after an years time will

be INR 1,20,000 (INR 120 * 1000) and Value of Fund B will be INR 1,20,000 (INR 24 * 5000).

It is clearly evident that it is not the NAV but the expected return generated in future should be a

determining factor to choose the fund.

Myth II: Again, many investors have the misconception that higher NAV has already appreciated as

compared to a fund with lower NAV and thus, the fund with lower NAV is cheaply valued.

Here, we consider NAV of three funds and then compare the performance of those funds after a certain

period. Suppose after one year, the NAV of three mid-cap funds i.e., Sundaram Select Midcap Fund,

Kotak Midcap Fund and JPMorgan India Smaller Companies Fund as at 30 October 2009 was INR 117.52,

INR 19.17 and INR 5.91 respectively. The return generated after one year is 43.09%, 50.89% and 43.22%

respectively (as at 30 October 2010). If lower NAV funds were cheaply valued then JP Morgan India

Smaller Companies fund should have given highest return but, Kotak Midcap fund has given maximum

return out of the three funds even though, it’s NAV was higher than JP Morgan India Smaller Companies

Fund. In addition, albeit there was huge difference between the NAVs of Sundaram Select Midcap Fund

and JP Morgan India Smaller Companies fund, the one year return generated by both funds has been

similar. Hence, it is not the NAV but the way the fund is managed determines the future prospect of the

fund.

Myth III: New Fund Offers (NFO) are attractive as they are available at Rs 10

Many investors are also of view that s/he should invest in an NFO as the same is available at INR 10

whereas the existing fund with the same objective is at a higher NAV. Plus, some investors even prefer

to sell the old fund and buy the new fund.

Say, the Fund A was launched in the year 2000, and the current NAV of the fund is INR 100.

Now new fund i.e. Fund B is launched which has same mandate as Fund A. As Fund B is an NFO, the NAV

of fund is INR 10

Assume that both the portfolios are invested in same 5 stocks and have 20% weightage in each stock as

at 30 October 2010.

Illustration

As shown in the illustrative table, at 38.40% CAGR in one year, the NAV of Fund A would increase from

INR 100 to INR 138 and NAV of fund B would increase from INR 10 to INR 13.84. Thus, even if the

investor had invested in any of the above funds, the return from the portfolio irrespective of the NAV

would be at par.

So, investing in NFO instead of existing fund because of lower NAV is irrelevant and if any advertisement

campaign uses this as a base to promote the fund is nothing but mis-selling.

Myth IV: Since NAV of dividend option is lower than growth option, should I select dividend option?

Generally, for the same scheme, the NAV of dividend option is lower than that of growth option and at

times, investors consider this as an evaluation criterion while buying a fund.

Suppose an investor decides to invest INR 1000 in both, Dividend Re-invest and Growth option of the

fund.

Now, let us check the difference in terms of portfolio value if the investor holds the fund for two years.

Particulars Dividend Option Growth Option

NAV INR 10.00 INR 20.00

No of units 100 50

Return in 1 year 20% 20%

NAV at the end of 1st year INR 12.00 INR 24.00

Dividend declared (per unit) INR 2.00 NA

Total dividend received INR 200.00 NA

NAV - post dividend INR 10.00 24

Additional units issued 20 NA

Return in 2nd year 20% 20%

NAV at the end of 2nd year INR 12.00 INR 28.80

Dividend declared (per unit) INR 2.00 NA

Total dividend received INR 240.00 NA

NAV - post dividend INR 10.00 INR 28.80

Additional units issued 24 NA

Total units 144 50

Portfolio value INR 1,440.00 INR 1,440.00

Source:iFAST Compilation

As we have seen in the above table, although the NAV of growth option was higher than dividend

option, after two years the portfolio value remains the same.

NAV of dividend option remains at INR 10 because in dividend option the investor gets cash dividend

from the scheme and accordingly, the NAV of the scheme falls by same amount. As a result, NAV of

dividend option is lower than growth option which is true for most mutual fund schemes.

Hence, NAV of dividend and growth option should not be a determining factor.

While selecting a fund, if investor has a long-term horizon with capital appreciation as objective, he

should opt for growth option, but if investor is looking to get some return from his investment on a

regular basis, he can select dividend payout option.

Conclusion

The article aims to highlight that the current NAV of a fund should not be a determining factor for

purchasing any fund. Investments in a lower NAV fund as compared to a higher NAV fund does not imply

better performance in future. Hence, investors should look at other indicators, such as mandate of the

fund, the fund's past performance, how long the fund is in existence, size of the fund, the fund

manager’s experience and history in managing the fund etc., before making final decision to buy a fund.

Disclaimer

This article is for information purpose only. This article and information do not constitute a distribution, an endorsement, an

investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial

products /investment products mentioned in this article or an attempt to influence the opinion or behaviour of the investors

/recipients. Any use of the information /any investment and investment related decisions of the investors/recipients are at their sole

discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives

of the specific person or group of persons. Opinions expressed herein are subject to change without notice.