Sunday, October 24, 2010

Understand Net Asset Value (NAV) in Mutual Fund

Although Net Asset Value (NAV) is a general term but it is commonly used in relation to unit trust or mutual fund. If you invest in stock, then you probably know the stock price for each single unit stock.

So, NAV is something similar to stock price but it is usually meant for unit trust or mutual funds or exchanged-traded funds(ETF). NAV per unit is the price or value of each single unit of the funds. Let’s look at the formula:

NAV per unit = (Total Asset of the Fund – Total Liability of the Fund) / Total Number of Units

Note: When people say NAV, it usually refers to NAV price per unit of the fund although the "per unit" is not explicitly mentioned.

For example, if the total net asset of the Fund A is $100 million and the number of unit issued to the public is 150 million units, the NAV would be ($100M/150M) = $0.67 which is 67 cents of each unit of Fund A.Well if you’re not finance people, this is probably too technical for you. Let's make it the simpler definition of NAV. NAV is the unit price of a mutual fund! Is this simple enough?

What does NAV mean for you?
It basically really means NOTHING to you. Okay, okay, perhaps something. It tells you the value of the unit price of a mutual fund. Just like stock, it tells you whether a fund is too expensive or is still cheap? Wait a minute! Can you really tell? No, you don’t because it is all about comparison. You need to compare at least 2 funds to tell whether the NAV is expensive or cheap. 

FUND N.A.V ($)
A 0.67
B 0.90

If Fund A is cheaper than Fund B, what does this mean? It means you can buy more units from Fund A with the same amount of money. E.g. with $1K, you can buy ($1K/$0.67) = 1492.54 units from Fund A and ($1K/$0.90) = 1111.11 units from Fund B. 

But does this mean you have more units and you will earn more? No, it does NOT tell you the performance of the funds because the value of your investment is always the same which is $1K. So eventually, it basically means NOTHING to you too. Unless Fund A and Fund B started out the same day with the same price, then you can only tell that the Fund B performance is better than Fund A or else you can’t conclude anything out of it.

In my opinion, the NAV of unit trust or mutual funds doesn’t really mean anything. It just tells you the current price of the unit trust but it doesn’t tell you the performance of the fund. You shouldn't buy a fund because of it's NAV is cheap. When choosing a unit trust or mutual fund, one should look at the fund’s financial objective, how good is the company management and does the fund has shown any good track record and etc.

On the other hand, don’t forget the investment is all about emotion too. Let’s look at the Fund A vs Fund B above. What do you think majority of people will buy? Fund A or Fund B? Fund A is cheaper right? So the chances for Fund A to go up is higher than the chances for Fund B to go up? So when everyone buy Fund A, the price of the Fund A will go up eventually?

So now back to you, will you buy fund because of the cheap NAV?


Kenny said...

Usually IPO has lower NAV price and has high potential to go up.

ChampDog said...

Yes, probably. That's why the mutual fund companies like to keep introducing new funds and sometimes they give discount too for new fund. People usually very willing to invest in new fund as compared to old fund because the perception of cheap NAV.

But still, I have seen fund is losing since it launched. Perhaps you're right the chances of going up is higher but we still need to look at the fund's objective and etc...

Chong Kong Hui said...

Please correct me if I'm wrong - Price will not goes up just because of more people buying into it UNLESS we are talking about a Exchange Traded Fund.

Fund of a mutual fund will only goes up when "the return" less "the charges" is positive over a long period of time, i.e. the gain makes the price move up.

ChampDog said...

You have point here. Mutual fund or unit trust is based on on the NAV and not really on demand of the funds unlike the close-ended funds such as ETFs.

However, I'm not sure if that will "indirectly" affect the price too. If more people demand a particular mutual fund, the more funds that fund manager can play around and that may eventually can push up the underlying stocks. Thus, NAV goes up too.

I'm comparing a fund that has high demand than the other, will that somehow affect the fund's performance indirectly? Of course the fund manager still can screw up everything...

Kris said...

Yup. How high/low a NAV don't really tell the fund's perfomance. It is better to look at which sector the funds invests in.

IMHO, if the new funds is in great demand , usually the issuer will top-up the number of units for sale. Having said that,IMHO new funds may not performed as spectacularly as older funds because it takes some time for the manager to invest the money in stages.

Having said that, sometimes with large fund size/capital, the manager must be very capable to select the stocks so that it can give a significant return. Usually the bigger you are the harder it is to get high percentage returns.

For example , Warren Buffets needs to invest/take over a company so that it can consistently get higher returns. Other than that, the profit would be insignificant in percentage terms of total capital.


ChampDog said...

Interesting, so older fund usually performs better. But isn't that the new funds will eventually become older fund too? I think if your investment is meant for long term (> 5 years), then it should be fine.

Hmmm... it seems like large fund size also has it own problem then? Is this also one of the reasons why so many new funds being introduced?

Having said so, it is still up to the fund manager. They can decide the right amount to close the fund and do not allow any more investors.

Kris said...

"They can decide the right amount to close the fund and do not allow any more investors" - This will not happen because fund managers earned around 1-2% or more annual management fees based on the size of the fund and not based of the funds performance.

So bigger funds more $$$ annually. That is why you see you know who, almost every month has launched new funds!!! especially when the market is hot, it is a good opportunity for them.

ChampDog said...

I see, I see... :) Will do more research on this see whether if we can find the common pattern.

Kris said...

That the reason why i always tell my friend that if there is a bull market, most mutual funds will go up regardless which institutional issues.

"Most" here usually means equities, commodities based funds, not saving or bond type :P

Chong Kong Hui said...

Hi ChampDog, did you remove the comment from the agent putting his contact number? I was thinking to criticize that fellow for no-contribution but mere advertising.

To Kris's comment - Price doesn't reflect the performance, Yes, I agreed. You can only know or confirm the performance by looking into the "trend" and comparing to Benchmark.

Why most equity-based mutual trust fund will improve when market is hot? Of course the price will up because most counter "in theory" is appreciating in value. Ideally that is the right time you redeem the units to CASH or switch to bond/saving fund. Why? Because the fund manager can't simply dispose the share and convert into cash. They have to follow rules. We, the investor, do not have to follow that rules.

For the management fee. It is ok if the fund management fee is 2% if the performance is consistently outperform the benchmark. It is NOT OK even if only 1% if the performance is BAD. So, don't judge a fund by the management fee.

ChampDog said...

I agree that is usually the case.

Huh? You mean on your blog? I usually just remove their comments if merely for advertising. They're a lot actually, some even sounds like a real comment but you need to look at them carefully and those are usually generic comments which can be apply to anywhere. :D Welcome to the blogosphera! :)

Yes, trend probably is the right thing to do rather just only look at the price if we want to look at the potential high return funds.

Very nice said Chong, I agree that is one of the thing the fund manger cannot simply do. This is how the unit trust system is designed, you don't go up or go down too fast. That's the reason they need to follow certain rule make sure this happens. One thing is, when is the right time to switch to Bond or sell it?

There has been a research on this - the return of unit trust or mutual fund is about the same in long term. If that is true, the fund management fees play a very important role to determine the performance of the fund. In other words, the lower the fund management fees, the higher the return. The lower fees fund usually lost in short-term and win in the long run. Interesting, huh?

Kris said...


I do agree that if for 1-2% a fund manager can give me superior returns, them i am good with it.

However, not all funds make good returns. Some do and some don't. What we lost is opportunity costs aka time.

When to switch? It all depends on an individual risk appetite profile. And also the market conditions.

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