Lowest NAV Mutual Fund Does Not Mean Undervalued

Mutual fund investment is all the rage right now with people from every walk of life investing in mutual funds according to their capacity. For a seasoned investor, investing in mutual funds might be easier, but for a common man who wants to start investing, some terms related to mutual funds might be confusing and misleading. Right at the top of this list is the term ‘NAV’ or Net Asset Value.When we buy units of mutual funds, and even when we look at how our funds are performing, we get to see the Net Asset Value of the mutual fund we invested in. When this value goes up and down, many investors think that this is similar to how the price of a stock goes up and down, but this is simply not true. To understand why, let us go right at the beginning and understand what a NAV really is.

NAV is short for Net Asset Value. A mutual fund is a big package with different assets like stocks, bonds, government securities etc. Now this entire mutual fund must have a total value, right? Let us consider that the total value of this whole package is Rs. 1000. Now the fund house wants to sell this package to investors.But how does one sell a package to different investors that has many different stocks, bonds and other financial securities inside it? The answer: Break the package down into several units. Now this entire mutual fund package is broken down to, let’s say 100 units. So, a package with a value of Rs. 1000 has been broken down into 100 units. Now the fund house can sell these units individually to whoever wants to invest. So, what will be the cost of one unit? Total Value of Assets(Rs. 1000)/Number of units(100) = Rs. 10 Thus, the Net Asset Value, or NAV of our mutual fund is Rs. 10. This NAV is the per unit market value of the mutual fund. It is the number you get when you divide the total market value of a mutual fund (excluding liabilities and expenses), with the total number of outstanding fund units.

One must understand that a NAV is just the total value of the mutual fund. If it is higher it only means that the particular fund has prospered very well since its inception and the value has grown. The NAV in no way reflects the future prospects of a particular mutual fund. Rather than looking at the NAV, an investor must look at the fund’s track record and past performance.

Investors always have the misconception that makes them see the NAV value similar to the price of a stock market share. But that is not true. The share price is decided by investors in the stock market, whereas the NAV is simply the total value of the mutual fund per unit, and it is not decided by investors.Also, many independent investors feel that if the NAV value is low, this means you must buy more units because you’re getting them at a low price. Again, this is a common misconception. A lower NAV does not mean that the fund is undervalued. If your main goal is to buy an undervalued fund, then you must not go only with the NAV value to make your decision. Let us look at a small example to make this case:Suppose we have two mutual funds named MF1 and MF2, with a similar portfolio. Both mutual funds have a market value of Rs. 100 million.So, we can assume that both MF1 and MF2 have a similar standing when it comes to market value.Now let us assume that MF1 has 10 Million outstanding units and MF2 has 12 Million outstanding units.If we calculate NAV: Nav of MF1 : 100 million/10 million = Rs. 10 per unit Nav of MF2: 100 million/12 million = Rs. 8.22 per unitSo, if you want to invest in an undervalued fund, you’d jump on MF2 because it has a lower NAV, correct? But we know that both funds have exactly the same market value!Therefore, it is evident that the NAV has no say whatsoever in whether a mutual fund is undervalued or overvalued. You cannot say that a mutual fund is cheap or costly just because the NAV value is high or low.

If you’ve two mutual funds to choose from, one which is considered a poorly performing fund with a poor track record, while the other is a prospering fund with a good track record. If the poorly performing fund has a lower NAV, does that justify an investor buying it thinking that the fund is undervalued? Of course not.Your decision on buying a mutual fund should not rest solely on the NAV of the fund. This may lead to you to buy poorly performing funds and restrict you from buying good funds just because the NAV is high.Your decision to invest in a mutual fund should be based on how the fund has performed in the past, the returns, the track record, whether the fund is equity based or debt fund based, and your own goal for which you’re investing.

Thus, it is very much evident from all this that the NAV has no relation to how a fund is performing. A lot of funds with lower NAV can give better returns than those having higher NAV. The NAV becomes irrelevant if you’re getting excellent returns. So the next time you choose a mutual fund, base your choice not on the NAV but on the fund’s future prospects.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.