Why you should not look at mutual fund NAV while investing

When investing in stocks, prices are very important; brokerage houses issue buy and sell recommendations with specific price guidance. There are many similarities between stocks and mutual funds, because the underlying portfolios of equity mutual funds are composed of stocks. Mutual Fund NAV or Net Asset Values (NAVs) are analogous with stock prices; they usually rise when the market rises and falls when the market falls. Many investors look at mutual fund NAV in the same way as they look at stock prices, but this may cause them to make wrong investment decisions. In this article, we will discuss some common misconceptions about mutual fund NAV.

Let us first discuss what mutual funds are. Mutual funds are financial instruments which pool the money of many investors and invest them in financial securities like stocks, bonds, debentures etc., for a variety of investment objectives.Investor in a mutual fund scheme own units of the fund which represents a percentage of the holdings of the scheme.

The price of a mutual fund scheme unit, also known as the Net Asset Value, will depend on the value of the underlying securities of the scheme portfolio. The mutual fund NAV is calculated by dividing the net assets (value of the securities and cash held by the fund minus the liabilities) of the fund by the total number of units outstanding.

You can check the NAV of any scheme here – Historical NAVs of mutual funds

An important difference between a mutual fund and stock is that a unit of mutual fund by itself has no value; mutual funds derive their value from underlying stocks. While the price of a stock depends on the demand and supply of the stock in the equity market, the NAV of a mutual fund scheme does not depend on the demand and supply of the fund. It depends in the value of the portfolio of securities, which the fund manager invests in.

Higher or lower stock prices relative to its own history may imply over-valuation or under-valuation. This is not the case with mutual funds. Mutual fund schemes are launched at par value (Rs 10) and the current NAV reflects the growth in the asset value since inception. Older schemes will have higher NAVs and newer schemes will have lower NAVs. This does not mean that older schemes are expensive and newer schemes cheap. A newer scheme may buy richly valued stocks and still have lower NAV compared to an older scheme which buys undervalued stocks. The point is that mutual fund NAV of a fund will not tell you, whether the stocks in the portfolio are over-valued or under-valued or fairly valued.

New Fund Offers or NFOs are always cheap because they are available at par value (Rs 10). As mentioned earlier, the par value of a mutual fund unit is derived from the value of the underlying securities in the scheme portfolio + the profits accumulated since launch of the scheme. Please note that different mutual fund schemes may have the same securities in their respective portfolios yet they may be offered at different NAVs. For example – one scheme may have NAV of Rs 10 and the other scheme NAV might be Rs 100; the difference in the price notwithstanding the intrinsic value of the schemes having the same portfolio is exactly the same. The annualized growth in mutual fund NAV over a period of time is the relevant measure of mutual fund performance.

Check the latest NAVs of mutual fund schemes in India

Investors often book profits in stocks which see considerable price appreciation in the hope of an impending price correction. Buying low and selling high is one the fundamental tenets of equity investing, but the same does not apply in mutual funds. You should remember that an equity mutual fund is essentially a collection of stocks and therefore the price behaviour of a mutual fund will be very different from price behaviour of individual stocks. Mutual funds, unlike stocks, offer risk diversification and should be purely for investment purposes over a long investment horizon.

Funds which have performed well, on a risk adjusted returns basis, are likely to perform well in the future also. By booking profits in mutual funds, which have done very well for you, you may get immediate cash-flows and psychological gratification, but like the proverbial golden hen, you will be giving up on future returns.

Many investors like to hang on to stocks where they are making losses or getting very low returns, in the belief that, at some point of time these stocks will bounce back because the investor thinks that the stock is undervalued. However, the same logic should not be extended to mutual funds.

In mutual funds, the investor is not investing in a stock where he or she has great conviction in the long term even though it may be underperforming due to some specific reasons.A mutual fund investor essentially invests in the fund manager’s abilities to pick stocks which will give good risk adjusted returns in the future. While a fund may underperform in the short term, due to the strategy adopted by the fund manager, if the fund underperforms in the long term (3 years or more), it may be prudent to exit the fund and invest in funds which outperform consistently. Some stockbrokers advise their investors to buy stocks when they are making losses to average out the purchase price, but investors should not allocate incremental monies to mutual fund schemes which are underperforming; they are better off investing in better performing mutual funds.

How to select the top performing funds – See the selected list of top ranking funds in any category