Wednesday, January 30, 2008

"What is the level of NAV?"

As much as I hate to admit this, mis-selling in the Indian mutual funds (MF) industry is as much the industry's and the agent's fault, as much as the investors'. Ok, well, the MFs and agents have the upper hand, but investors clearly get swayed by greed and agree to buy whatever comes their way, without wondering what they're getting into.

For instance, one question that many people ask me after I recommend a fund for them is: "What must be the NAV of this fund now?" If I say something like 70+ or even 100+, they immediately retort by saying it's too expensive! Even regular readers of my magazine and those whom i advice regularly about MF investments, raise this doubt every once in a while about my recommendation's NAV level. The lower the NAV, they say, it's cheaper to buy it. Despite educating investors and readers regularly, this is the biggest MF myth that we (responsible) correspondents and analysts have repeatedly tried to break, but, with very negligible success. It's called the 'Rs 10 myth'. In simple words, a fund whose NAV is at Rs 10 is not necessarily better than the fund whose NAV is at Rs 50.

Let me explain. Assume there are two funds, 'fund A' whose NAV is at Rs 10 and 'fund B' whose NAV is at rs 50. Assume also that both these funds have invested their entire corpuses in HUL at, say, Rs 100 per share. Now if HUL moves up by 5 per cent, both the funds would also move up 5 per cent. So A's NAV will be 10.5 and B's NAV will be 52.5. Both the NAVs have gone up by an equivalent margin, i.e. 5 per cent. If however, if A had invested in HUL whose market price went up by 5 per cent, and B had invested in ABB that went down by, say, 10 per cent, fund A would hve experienced a gain, while fund B would have experienced a loss.

How high or low a fund will go, depends on the underlying investments of a MF scheme. Investments in MFs is different from investment in shares. While equity shares are bought of companies that you think would do well in future and whose share prices would rise to reward you, a mutual fund is an investment vehicle through which you invest in a variety of companies by buying their shares and bonds. A share price goes up or down, depending on what the equity market perception is about that company in terms of its future growth, sales, profitability and business model.

A mutual fund’s net asset value (NAV) - similar to a share price - doesn’t rise or fall the same way. As mutual funds invest in shares and bonds of companies, it depends on the fund manager’s intellect and perception about which companies, in his opinion, would or won’t do well. He’s a professional in whose hands you entrust your money in, to manage on your behalf. If the underlying companies do well, your MF’s NAV rises, else it falls. Your MF’s performance, therefore, hinges on your fund manager’s ability to pick up the right kind of stocks and profit from them. Hence while a company with a lower share price, in many cases, is better than those with a higher share price, a lower NAV MF is not necessarily better than a higher NAV one, because a share price is largely driven by market perception and a MF’s NAV is more of a function of its fund managerial skills.

The true picture: The next time you see a higher NAV, remember that the fund's NAV is higher than others is because this fund, and thereby its NAV, has been in existence for a long time. Since a new fund starts at Rs 10, over a period of time and years into its existence, the fund's NAV would gradually and eventually keep rising. This is why its NAV is higher and not because it is "over-priced" or something. Actually, MFs can never be over-priced or under-priced. As NAV stands for Net Asset Value, it just reflects the value of the underlying assets, plus all the profits that it has booked since its inception.

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