Is a fund with a low NAV a better investment option than a fund with a higher NAV? Since you can buy more units when the NAV is low, isn't it cheaper? Should mutual fund schemes with a higher NAV be avoided? These are questions, which trouble many first time investors in mutual funds.
The answer to these questions is that it is irrelevant how high or low the NAV of a fund is. This seems difficult to accept but is better explained by understanding NAV. NAV or net asset value is the sum of all assets held by the scheme divided by the number of units. Let us understand how the value of this number is unrelated to the performance of a fund, with an example. Suppose the portfolio of a hypothetical Fund A consisted of BPCL, Infosys, SBI and Ranbaxy. The fund held a thousand shares in each company. The number of units in the fund is 1.5 lakh. On September 27, 2001 when the markets plunged to abysmal depths, this fund's NAV was Rs 22. Another equity fund B held the same four stocks but had a lower NAV of Rs 13. If an investor decides to buy units worth about Rs 20,000 in each fund, he wo-uld get 909 units in Fund A at Rs 19,998 and 1,538 units in fund B at Rs 19,994. Since fund B provides more units, it appears better. But let us see what happens to the returns from these schemes.
By the eve of Budget Day 2002, the markets had risen considerably. The NAV of scheme A had risen to Rs 34.93 while that of scheme B was now Rs 20.64. The investment in fund A was worth Rs 31,751 (909.09 units x Rs 34.93) and the investment in fund B was worth Rs 31,744 (obtained as 1,538 x 20.64). The return on both these investments is 58.7 per cent, which is the same as the change in NAV. The difference of Rs 7 arises because the amount invested in fund B was Rs. 4 lower than in fund A. The returns are the same because the stocks in both portfolios are the same. A finer search would disclose that the proportion of stocks is the same in both portfolios. It is clear that it is the stocks in a portfolio that determine returns from a fund, the value of the NAV being immaterial. Here it should be pointed out that calling one scheme as costlier than the other, based on the NAV is also wrong. Though one scheme has a higher NAV, the only result of this is that one gets a smaller number of units.
When one sells those units, the return will be the same as that of another scheme, which has performed similarly. The 'cost' of a scheme in terms of its NAV has nothing to do with returns. What you want to buy in a scheme is its performance. The only instance where a higher NAV may adversely affect you is where a dividend has to be received. This happens because a scheme with a higher NAV will result in a fewer number of units and as dividends are paid out on face value, higher NAV will result in lower absolute dividends due to the smaller number of units. But even here, total returns will remain the same.
So from whichever angle you see it, the NAV makes no difference to returns. Mutual fund schemes have to be judged on their performance. And the simplest way to do this is to compare returns over similar periods.
This article was originally published on January 09, 2003.
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