What is NAV (Net Asset Value) in Mutual Funds?

Wondering what is NAV in mutual funds? Keep reading to find out.

What is Mutual Fund NAV? 

What is the Net Asset Value Formula?

To calculate the net asset value, Asset Management Companies (AMCs) use the following mathematical formula.

Since mutual funds invest in market-linked securities, the value of their assets is subject to change frequently. It is for this reason that the Securities and Exchange Board of India (SEBI) has mandated all mutual funds to calculate and publish their NAV at the end of each trading day.

Net Value of Assets for Mutual Funds

The net asset value of a mutual fund is dependent on three components – assets, liabilities and outstanding units. Here’s a more detailed overview of what each of these components represents. 

• Total Assets 

Total assets represent the total market value of all of the assets held by the mutual fund. It includes both securities, cash and cash equivalents and other receivables that the fund has. In the case of market-linked securities, their value is determined by multiplying the number of units of the securities the fund holds by their closing price.

• Total Liabilities 

Total liabilities, meanwhile, represent all the expenses and obligations in connection with the fund. It includes administration expenses, fund manager’s salaries, marketing expenses, and agent commissions, among others. The liabilities may also include interest payments to lenders from whom the fund has borrowed money and other charges that the fund owes to associated entities. 

• Total Outstanding Units 

Finally, total outstanding units represent the number of mutual fund units as of the date of NAV calculation. Now, like both assets and liabilities, the total outstanding units also change frequently. For instance, new units are created when a new investor invests in a fund, which increases the number of units.

NAV in Closed-End Funds vs Open-End Funds

• An open-ended fund has an unlimited supply of units. These funds are not traded on the exchange, and their NAV value doesn’t change throughout the day like stocks. As per SEBI’s guidelines, the NAV of a mutual fund is calculated at the end of the day after trading hours.
• Close-ended funds trade on the stock exchange like stocks. They can trade at a premium or discount value as compared to their NAV.

What is the Distinction Between NAV & Market Price?

While you may think that NAV is similar to a share price since both of them are reflective of the respective fund/ company’s worth, this is not the case. Unlike share price, which is determined by the supply and demand dynamics, NAV is based on the market value of securities, after factoring in liabilities and funding expenses.

Additionally, a fund’s NAV is not indicative of its future performance, which is in contrast to a company’s share price, which is emblematic of a company’s prospects.

A mutual fund’s NAV value does not go up because of increased demand. This value rises only when the market value of AUM surges.

Finally, instead of being dynamic like a share price, NAV is calculated at the end of a day after the markets close.

How is Mutual Fund NAV Calculated?

Now that we know NAV is not similar to a share price, how do we calculate NAV? Primarily, a fund’s NAV can be computed by two methods: General NAV calculation and Daily NAV calculation. We explain them below

General NAV Calculation

A better way to understand the General NAV calculation is through an example. Assume you wish to invest in a mutual fund with a current NAV value of Rs. 100 via SIP of Rs. 50,000 per month. As a result, you can purchase 50 units per month on the day of purchase.

Daily NAV Calculation

SEBI has mandated all AMCs to calculate a fund’s NAV daily and post it by 9 pm on their websites. Thus, when the markets close, fund houses estimate the final value of their portfolios, and calculate the NAV, also known as the closing price, of the fund. This price becomes the opening price the next day.

The following net asset value formula is used to calculate the closing price of a mutual fund:

NAV formula = (Assets – Liabilities) / Total number of outstanding share units

To illustrate, consider a fund that has Rs. 300 lakhs in assets, Rs. 100 lakhs in liabilities, and has issued 10 lakh units to its investors, then

NAV = Rs. (200 – 100) / 10

NAV = Rs. 20 per unit

Investors must note that funding expenses, such as administration & management expenses, distribution costs, advertising expenses, etc., are proportionally charged and adjusted in the fund’s NAV calculation. Thus, a fund’s NAV is similar to a company’s book value as it adjusts the total value of cash and securities held for liabilities and divides this value by the units outstanding.

What is the Role of NAV in Decision Making?

Even though the NAV values are updated daily, surprisingly, they have very little relevance when it comes to making the final call about investing in a particular mutual fund.

To illustrate, below we state the NAVs of a few funds as of 30th October 2022:

Can you glean any information about these funds solely from their NAV values? Does a lower price indicate undervaluation or a buying opportunity? The answer to both questions is No. Hence, we cannot compare funds only on their NAV values. Nor does a higher NAV price signal the fund is better. It only implies that the fund has a higher asset value. Since a mutual fund distributes all its income and realised gains to the unit holders, a fund’s NAV is not very relevant for gauging its performance. Instead, investors should focus on the total return generated by the fund to evaluate its performance.

Role of NAV in the Performance of a Fund

Investors often track the progress of a fund’s net asset value to understand how the fund has performed over the years. However, the NAV doesn’t impact the actual returns generated by the fund in any way. A higher or a lower NAV doesn’t actually mean that the returns from the fund would be commensurate.

Unlike close-ended schemes, open-ended mutual funds can be bought and redeemed at any point in time. This makes the net asset value a very important metric that you need to look into when investing in them.

This is why the SEBI has set cut-off times for different mutual fund units. You will be allotted the NAV based on when the request is placed relative to the set cut-off time. For redemption requests, the NAV you’re allotted is dependent on the time of request placement. In the case of purchase requests, however, the NAV you’re allotted is dependent not on the time of request placement, but when the funds are realised by the AMC. Here’s a table outlining the cut-off times for different funds.

Should You Invest in a Fund with a Low NAV Value?

As mentioned above, a lower NAV value is not reflective of a cheaper valuation or a buying opportunity. Instead, it only specifies a lower asset base. Let’s understand this concept through an example. Assume an initial amount of Rs. 30,000, which can be invested in either Fund A or Fund B.

Here, a hypothetical fund B has a lower NAV value, which results in a higher unit allotment. Assuming a 10% growth rate in both funds A and B, the new investment value of both funds A & B remains the same. Thus, a NAV value simply signifies the cost of buying units at a specific point in time. A higher NAV may, however, suggest that the fund is older, thus explaining the bigger AUM. But NAV values are not a useful indicator of fund performance.

How is the Applicable NAV Determined?

As per the mutual fund investment guidelines, the fund’s NAV is calculated only once during the day, at the end of the trading session. The formula for calculating the NAV is (Total AUM – Liabilities)/(Total number of units). One can invest on any business day, but the applicable NAV is calculated following the table below.

What is the Sale and Repurchase Price?

The sale price is the cost paid by the investor for each unit of the scheme when buying or switching in from another fund. For open-ended funds, the sale price is the same as the NAV of the fund.

The redemption price is the price paid per unit by the mutual fund company at the time of buybacks (the investor is selling or switching out). The formula used for calculating the repurchase price is the one below.

Redemption Price = Applicable NAV*(1- Exit Load)

For example, if the applicable NAV is ₹100 and the exit load is 2%, the repurchase price will be = ₹100* (1-0.02) = ₹98. It is important to note that, as per SEBI rules, the repurchase value of an open-ended fund shall not be lower than 95% of the NAV.

What are the Trading Timelines for NAV?

NAV is calculated once a day, and therefore, all buying and selling orders are computed based on a cut-off time at the NAV of the trade date. For instance, if the cut-off time is 1:30 PM, all buy or sell applications received before 1:30 PM, will be calculated on the NAV of the same day. And, orders received after the cut-off will be processed the next business day. New cut-off timetable by SEBI.

What is NAVPS?

NAVPS reported to the broker or the online financial portal is the price of each fund share. NAVPS stands for Net Asset Value Per Share. NAVPS can be slightly different from NAV, which is the fund’s AUM minus any liabilities divided by the number of units.

Bottom Line

A mutual fund’s NAV merely shows the price for buying or selling units; it is not an appropriate measure to compare a fund’s performance to its peers. Instead, investors should rely on other parameters, including historical performance trends, expense ratios, and the quality of management, before choosing to invest in a mutual fund. Investors can choose to invest through a SIP, as it counters NAV fluctuations, resulting in rupee cost averaging.

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