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What is Mutual Fund NAV(Net Asset Value)?

What is Mutual Fund NAV(Net Asset Value)?: Overview

Net Asset Value or NAV is defined as the per unit value assigned to a mutual fund scheme. In other words, the NAV is the price at which an
investor purchases mutual funds from the primary market i.e. the asset management company (AMC). The NAV is also applicable to unit
redemptions or switches that an existing investor might make at a later date. An increase in NAV over previous levels indicates that the fund is
making profits, while a decrease in NAV indicates that the fund’s investments are incurring losses.

The basic understanding of mutual funds would be incomplete if one does not understand the accounting principles behind it properly which
comprises among other things the valuation of schemes and calculation of net asset values. Net Asset Value is the price per unit value of the
mutual fund. Mutual funds are for the most part priced in a manner similar to which stocks are priced. So if an investor is purchasing one unit of a
mutual fund, he is purchasing that on the basis of the applicable NAV.

Mutual Fund NAV vs. Stock Price

However, the key difference between stock price and NAV is that unlike stock price, which fluctuates by the second during stock market trades,
the mutual fund NAV does not change throughout the day. The NAV does, however, change each day and is computed after markets close.
Therefore it is very important for an investor to know when the fund priced as that can change the purchase or redemption price. For e.g. if one is
purchasing today, then he may be actually purchasing at a NAV price which will happen at the end of the subsequent day. Let's look at how NAV
calculations are made with a simple example.

How to Calculate NAV of Mutual Fund

The NAV of a mutual fund unit changes daily and the reason for this lies in the way in which a fund’s NAV is calculated. The formula for NAV
calculation is as follows:

NAV = (Total Assets of the fund – Total Liabilities of the fund)/Total number of units outstanding.

Total assets of a mutual fund are obtained by calculating the total value of all stocks, bonds, cash, futures, treasury bills, ETFs etc. that the fund
holds. On the other hand, liabilities of a mutual fund include securities transaction charges, the total value of redemption requests pending, etc.
The total number of units outstanding also changes periodically. This is because the number of units that a mutual fund might have released
earlier may have come down over time as units may have been redeemed by existing investors. Hence the calculation takes into account only the
outstanding units of the fund.

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For example, let’s assume that a mutual fund has total assets worth Rs. 20,500, liabilities of Rs. 500 and number of outstanding units are 2000. In
this case,

NAV of the fund = (20,500 - 500)/2000 = Rs.10.

Why NAV Changes Only Once a Day

As mentioned earlier, the NAV of a fund is calculated based on the total assets, liabilities and outstanding units of the fund. But this calculation is
not as simple as the example provided in the earlier section. The first issue to consider is the number of securities/bonds etc. that the fund is
invested in. While some mutual funds may have less than 10 investments in their portfolio, it is not unusual for other schemes to have as many as
100 or even more. Then you have to take into account the number of shares of each security or the total quantity of each bond the fund is invested
in. Moreover, during the trading day, the price of securities and bonds can change every second or even faster complicating the NAV calculation
further.

Consider this – A fund is invested in shares A, B, C and D numbering 100, 200, 300 and 400 shares respectively. Now if the fund manager
decides to sell 100 shares of D and buy 50 shares of B, the allocation will change which may lead to a change in the NAV. In order to reduce the
complexity of this calculation, NAV of a fund is calculated only after all market trades have ended for the day. Also on days when markets are
closed i.e. when no trading occurs, the NAV of the mutual fund remains unchanged.

Illustrative Example of Changing NAV

Let’s see how a typical NAV change can occur with an example. Let’s assume a mutual fund holds 20 shares of Rs. 10 each as assets, has zero
liabilities and the number of outstanding units is 2. At the time of market opening, the mutual fund will have NAV = (20x10)/2 = Rs. 100. Now
let’s assume that at the end of the day’s trade, the market value of these shares has increased to Rs. 15, while all other fund data has remained the
same. In this case, the new NAV at the end of the day = (20x15)/2 = Rs. 150. Similarly, if the market value of the shares were to drop to Rs. 5, the
NAV = (20x5)/2 = Rs. 50.

The above example though simplistic should provide a fair idea of why and how NAV of a mutual fund changes. In practice, there would be
scores of securities and hundreds of thousands of units as well as substantial liabilities that need to be considered when calculating the NAV of a
mutual fund. Considering the complexity of the calculation it should be apparent why mutual fund NAV does not change in real time like that of
shares traded on the stock market.

NAV Change Impact on Mutual Fund Unit Purchases

The following section might seem quite obvious to many but in case you haven’t already figured this out, here goes. For an investment of a fixed
amount, a higher NAV will result in less units being purchased as compared to a purchase made at a lower NAV. In case you are wondering how
this would matter, consider cases where the number of units might be a contributing factor in determining your future gains. One case is
obviously dividend distribution.

In case you are investing in the dividend option of a mutual fund, you are liable to receive dividends based on not the amount you have invested
but in fact depending on the number of units of the fund you hold. This is primarily because dividends are distributed on a per unit basis as long
as there is a distributable surplus available to the scheme. What’s more, when a dividend is declared, the NAV decreases by an amount equal to
the amount distributed as dividend. So, if you have more units you can receive a higher dividend payout, however, the value of your investment
in the fund will decrease by an equal amount.

The other case is the rupee cost averaging that occurs in case of SIP transactions. In case of a SIP, a fixed amount is invested in a scheme of your
choice at regular intervals. Therefore you would be able to purchase fewer units when NAV increases as compared to when NAV is lower.
However, the actual cost price of the unit would be an average of all SIP transactions and this is termed as rupee cost averaging.
Let’s illustrate with an example.

Suppose you have a monthly SIP of Rs. 500 and at the time of the first transaction the NAV is Rs. 20. Therefore you will be able to purchase 25
units during the first transaction. If at the time of the 2nd transaction, the NAV increases to Rs. 25, you would purchase only 20 units. Thus on

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completion of these transactions,

you would have invested a total of Rs. 1000 and managed to purchase 45 units (20+25) in total. Thus your average cost price per unit = 1000/45
= Rs. 22.22. This though higher than the lowest price you got, is still less than the higher price that you can sell your units. This is how rupee cost
averaging benefits you in the face of changing fund NAV without having to time the market.

Key Points of Mutual Fund Nav:

NAV would be higher, if the scheme earns higher interest, dividend and capital gains.
Higher appreciation in the investment portfolio also leads to a higher NAV.
A higher scheme NAV would be also ensured, if the scheme expenses are lower.

NAV Myth Dispelled: Higher NAV is NOT = Better Performing Fund

In case you have recently been searching for funds with high NAV or low NAV then it is a wrong approach to choosing your investment.
However, are not alone in making this mistake. But a high NAV does not necessarily mean that the fund is a good investment and the following
section will explain why.

The origin of this myth lies in the fact that equity share prices and NAV are considered to be similar in nature however this is not the case. In case
of share trades, a company issues a finite number of shares through an IPO which are then traded on the stock market, which is essentially a
secondary market. Thus, the price of shares is closely linked to the demand and supply relationship i.e. in case a particular share is in high
demand, its price will rise and this will affect the market cap valuation of the company. The reverse will occur in case of low demand i.e. the price
will fall.

In case of mutual funds, the price of the underlying investment such as the stock or bond will fluctuate resulting in a change of the NAV of the
fund. Moreover, most of us buy mutual fund units directly from the mutual fund company, which is the primary market. And though there is a
secondary market for mutual funds, there is usually little or no action in this market especially in case of open-ended mutual funds. Thus demand-
supply relationship plays absolutely no part in determining the NAV of a fund. As a result, a high NAV could be a result of not just good
performance by a mutual fund, but also because the fund has been around for a long time. Hence, when choosing your mutual fund investments,
comparing the annualised returns generated by different schemes expressed as a percentage value is a better way to compare schemes rather than
NAV.

NAV Rules for Mutual Funds

As mentioned earlier, the NAV of a scheme changes daily and is calculated at the end of each trading day after markets have closed. So the
question arises at what price are you going to purchase your units? This is determined by the applicable NAV criteria and the cut off time of the
fund. For debt funds and equity funds in India, the cut off time in case of direct investments is 3 pm. However this may be as early as 1 pm in
case you are investing through a 3rd party intermediary such as a brokerage house. If you have placed your order for units and completed payment
before the 3 pm deadline, you will receive units based on the NAV of the fund as calculated after closure of capital markets on the same day. If
you put your order in after the 3 pm cut off time, your units will be allocated based on the NAV calculated on closure of markets on the next
working day. For example if you make your investment at 2:30 pm on the 21st of May, you will receive units based on the NAV calculated at end
of day on the 21st of May. In case you missed the 3 pm deadline on the 21st of May, the applicable NAV will be as per calculations made at the
end of the next working day.

Liquid funds work a bit differently as you can purchase these at the previous day’s rate too. The cut off time for previous day applicable NAV
purchases is 2 pm. If you place your investment request and complete the transaction (i.e. transfer the funds) by the cut off time, your units get
allotted based on the NAV of the previous day. If you miss this 2 pm cut off time, you will be allocated units based on the same NAV as per
calculations made after closure of stock markets. Taking the previous example, in case your liquid fund investment was completed before 2 pm
on the 21st of May, you will receive units as per NAV on 20th May assuming it was a trading day. Whereas, in case you were to complete the
liquid fund investment after 2 pm on the 21st of May, you will receive units as per NAV calculated on market closure of the 21st of May. These
applicable NAV rules are however correct only in case of individual investor investments of less than or up to Rs. 2 lakhs. In case of higher
investment amounts or institutional investors, different rules are applicable.

Portfolio valuation on the basis of Mutual Fund Nav

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Portfolio valuation is one of the key driving factors for NAV. While the exact number of each kind of security held in the portfolio is always
quantifiable, their valuation can be subjective. There are few guidelines that are prescribed when one can do a comparative study of the NAVs.

Whenever a security, say, Company X share, is traded in the market on the valuation date, its closing price on that date is taken as the value
of security in the portfolio. Thus the number of Company X's shares in the portfolio (say 1000), multiplied by the closing price (say Rs
1,700) gives the valuation of Company X's shares in the portfolio (1000 shares x Rs 1,700 = Rs 1700,000). Similarly, every security in the
portfolio is to be valued.

Where equity shares are not traded in the market on a day, or they are thinly traded, a formula is used for the valuation. The valuation
formula is based on the EPS of the company, its Book value and valuation of similar shares in the market (peer group).

Debt securities that are not traded on the valuation date are valued on the basis of the yield matrix prepared by an authorized valuation
agency. The yield matrix estimates the yield for different debt securities based on the credit rating of the security and its maturity profile.

There are few detailed norms regarding when a security is to be treated as NPA (non-performing asset), how much should be written off at
various points of time, when the amounts are written off can be added back to the value of the asset (treated as income), and when the NPA
can be treated as a standard asset.

Bottomline - Why NAV Matters

Since NAV reflects the price composition of all the holdings a mutual fund has in a scheme, when the prices of those securities are high, it
means the fund NAV is high. Conversely, if the total price of these securities is low, then the fund NAV is low. Therefore it is an important
factor to watch out for when investors are attempting to gauge the increase or decrease in value of their fund. The price of open ended funds
is not prone to rapid change as a result of investors purchasing or selling unlike market traded stocks. This is primarily because a mutual
fund has virtually no limits on the number of units it can issue at any given time.
As a specific mutual fund scheme enjoys investor interest and money keeps pouring into it, the company will issue new units for purchase
where the price per share is dependent on the securities available in the portfolio. When a particular stock is in high demand, it results in
high price as they are limited in the market for trading purposes. However, there are situations when the fund size grows so enormously that
fund managers make a call to restrict new investments into the scheme.
In case of a close ended scheme, the supply and demand drives the price of the fund units. Hence if the fund is traded at a price lower than
the NAV, it is called “discount”. Similarly if the fund is traded at a price higher than the NAV it is called “premium”.
It should be noted that the NAV of mutual fund units witness price changes from one day to another. Most mutual funds need to be held for
longer periods in order to be viable investment options in the long term. It is seldom practical for investors to try and trade the open-ended
funds to capture the profits earned with the swinging short term funds. Also the NAV does not reflect the value of any interest and dividend
that is paid out to investors. Therefore it is very important for the investors to have a look at the overall return of the fund in order to
understand its returns properly before making the investment.
When it comes to money markets, the NAV are quite stable in nature and they usually do not vary much as a result of day to day trading. As
their name suggests, they are mostly liquid in nature.
There are certain challenges when it comes to figuring the applicable NAVs. For e.g. challenges arise when an ETF holds securities in a
different time zone, because NAV is based on the last price quoted on the exchange during its closure.
Amidst all the challenges regarding calculation and applicability criteria, it is clear that NAV is perhaps the most important and a highly
useful metric for the investors to make their decisions regarding mutual fund investments.

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