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Net Asset Value (NAV) of Mutual Fund Scheme

1.   How NAV is Determined

In order to calculate the NAV of a scheme, each asset and liability of the scheme needs to be valued:

It can also be calculated as: Unit capital plus reserves.

There is a significant element of subjectivity in the valuation of assets. SEBI, has been trying to ensure some degree of standardization in the manner in which different AMCs handle this subjectivity. Accordingly, it has stipulated detailed valuation norms for each asset class.


Suppose a scheme with 1000 units has the following items in its balance sheet: Unit Capital Rs. 10,000 ; investments at market value Rs. 25,000; other assets (e.g, investments sold, but money not received) Rs. 4,000 ; other liabilities eg, investments purchased. but payment not made) Rs. 2,000; reserves Rs. 17.000.

What would be its NAV?

A good starting point would be to put down the numbers in a tabular form to ensure that all items are treated property and the value of total assets matches the value of total liabilities):

NAV = Total assets -  Liabilities other than to unit holders, i.e.:

= Rs. 29,000 – Rs. 2,000 = Rs. 27,000

Alternatively,     NAV = Unit Capital + Reserve :

=  Rs. 10,000 + Rs. 17,000 = Rs. 27,000

NAV Rate per unit =  NAV / No. of Units :

                = Rs. 27,000 / 1,000

                = Rs. 27

The NAV is required to be rounded to 4 decimal places in the case of index funds, Gold ETF and all debt funds, and 2 decimal places in the case of equity and balanced funds. Mutual funds can, after suitable disclosure in the Scheme Information Document, choose to round off the NAV to a higher number of decimal places in the case of equity and balanced funds too.

2.   Comparison of NAV of Mutual Fund between Different Dividend-related Options

Let us assume that the NAV of a scheme, which offers all three dividend-related options, has gone up from Rs. 10 per unit to Rs. 16 per unit. The scheme has now declared a dividend of Rs. 1 per unit.

Let us consider that an investor bought 1,500 units under each option (the results will be the same, whatever the number of units the investor starts with).

Thus, the investor’s net position is the same in all the options. However:

>>      In the case of dividend option, Rs. 1,500 is received in the bank, to which extent the NAV falls. Unit holding remains the same at 1,500 units.

>>      In the case of growth option, no dividend is received and there is, therefore, no fall in the NAV. Unit holding remains the same at 1,500 units.

>>      In the case of dividend re-investment option, NAV decreases to the extent of dividend declared. But since the dividend is re-invested, no money is received in the bank, but unit holding increases.

The investor would select the option that meets his cash flow needs and minimizes income tax. Subject to the impact of tax, the investor’s monetary value remains the same between the options, as seen below:

3.   Perspectives on NAV of Mutual Fund

(1)   Conservative and Aggressive NAV of Mutual Fund

The NAV of an open-end scheme is a key determinant of how much a person has to pay for each unit that she proposes to buy, as well as the amount she would recover if she sells a unit. Therefore, it is imperative to ensure fairness in calculation of NAV.

Accountants are trained to be conservative. Translated into operational terms, they would undervalue investments and over-provide for expenses. What is the impact of this approach?

If the moneys that an investor would recover on selling the units are determined by this conservative NAV”, then an exiting investor will recover lesser than what is really due. Concomitantly, a new investor will pay lesser than what she ought to pay for buying new units. Thus, it would penalize an exiting investor, while benefiting new investors and investors who continue in the scheme.

The reverse is an “aggressive NAV”, where investments are over-valued and expenses are under-provided. In this situation, an investor exiting from the scheme would take away more than what is due, thus penalizing the investors who choose to continue in the scheme. Thus, it would penalize new investors and continuing investors, while benefiting exiting investors. This is what happens in a Ponzi scheme.

Normal temptation for funds is towards an aggressive NAV because:

>>           It helps the scheme show better performance for the period; and

>>           Management fees are calculated on the basis of net asset value.

An aggressive NAV is like inflating the closing stock figure in the balance sheet of a manufacturing company. This closing stock also becomes the opening stock for the next period. Therefore, to sustain the performance, it will have to inflate the closing stock in the next period also. It becomes difficult to break out of this cycle.

Therefore, funds that use an aggressive NAV to demonstrate superior performance get caught in a trap from which it is tough to get out.

Neither a conservative NAV nor an aggressive NAV is fair. Fairness to unit holders comes out of a fair NAV. This is equally applicable to a closed-end scheme, where the units would be traded in the market place on the basis of the NAV declared by the scheme.

(2)   Historic and Forward NAV of Mutual Fund

As seen above, NAV is impacted by changes in both liability and asset sides of schemes. The general practice is to look at both liabilities and assets on day-end basis.

If the sale and re-purchase of units are effected on the basis of the previous day’s NAV, then it is called historical NAV basis. The danger in this is that if an investor can sell or re-purchase units after trading has commenced the next day, then she is able to benefit from information that is not factored into the historical NAV. This would be unfair to the other investors in the scheme.

An alternative for the mutual funds is to effect sale and re-purchase of units on the basis of the next succeeding NAV (forward NAV basis). In that case, an investor seeking to offer her units for re-purchase would not know how much she would recover until the end of the day. Similarly, a prospect desirous of investing a certain amount would not, at the time of effecting the transaction, know how many units she would be allotted.

Mutual fund schemes other than liquid schemes mostly transact on the basis of forward NAV. Investors are given the choice to define their re-purchase instruction in number of units or the value of units. Thus, an investor knows precisely, either the number of units or the value of the units that she would be offering for repurchase.

(3)   Real-time NAV of Mutual Fund

A few mutual funds have put in place systems whereby the asset side of the scheme can be marked to market on real time basis. This entails capture of information on sales and purchases of securities on an ongoing basis and weighting this with market feeds on current values of the securities. However, the liability information, viz, the number of units is still determined as of the end of the day.

With various forms of instantaneous money transfer coming into vogue, it would be possible to structure a scheme where even the liability side is factored into the NAV on a real time basis. This can facilitate real time NAV calculations.

Currently, only ETFs provide a mechanism for intra-day variations in the price at which investors can sell and re-purchase units. This variability, as seen earlier, comes on account of the market makers changing their bid and ask quotes, though NAV is only determined at the end of each trading day.

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