The way investors fall over each other to lap up NFOs (New Fund Offers) of mutual funds, it is very obvious that the meaning of NAV of mutual funds remains misunderstood.
How is the net asset value NAV of a mutual fund unit calculated is very important to know so that you can understand the dynamics of mutual fund investing – after all it is your hard earned money and could throw your entire financial planning in disarray.
Let us see with an example how NAV if calculated.
What is NAV ?
NAV is nothing but the total market value of all the assets held in the mutual fund portfolio less the liabilities, divided by all the outstanding units. That amounts to nothing but the “book value”.
The NAV measures how much each share of a mutual fund is worth. So essentially, the NAV of a mutual fund is the cost of one share of the fund.
How is it calculated ?
The total assets of a mutual fund usually falls into two categories – cash and securities. Securities include stocks and bonds. So the total asset will include the market value of all it’s cash, stocks, bonds. Liquid assets, dividends to be received, interest accrued also need to be included in the total assets.
At the same time, the mutual fund will have some money that it will owe to some creditors. That is it’s liabilities. There will be some expenses that has accrued over time and yet to be paid, this also needs to be included.
Let us see that in a formula.
Net Asset Value (NAV) = (Assets – Debts) / (Number of Outstanding units)
Assets = Market value of the fund’s investments + Receivables + Accrued Income
Debts = Liabilities + Accrued Expenses
The market value of stocks and debentures is taken as the closing price on the major stock exchange where it is listed.
As an example, assume there are two investors X and Y who have invested in a mutual fund which decided to issue out units at Rs 1/-.
X invests Rs 100/- and Y invests Rs 200/-.
The total corpus of the mutual fund will be Rs 100 + Rs 200 = Rs 300/- and X will get 100 units and Y will get 200 units.
Now suppose the mutual fund manager invests smartly over a year and makes the investment grow and the corpus becomes Rs 800/-.
The NAV will be calculated as :
NAV per share = (Assets – Debts) / ( Number of Outstanding Units)
= (Rs 800/- 0) / (300)
The NAV is 2.67.
So X’s value of investments will be 100 units * 2.67 = Rs 267/- and
Y’s value of investments will be 200 units * 2.67 = Rs 534/-.
In reality of course, there are liabilities and expense ratios to be taken care of, this is an example just for simplicity.
Other points to note
The NAV of a fund is calculated by the mutual fund house itself and in some cases by some accounting firms that the mutual fund might hire for this purpose.
Usually, the calculation of a NAV is impossible during market hours as the price of the underlying holdings (say stocks) keeps changing. Though the NAV can be calculated, it would change the next minute or second. Given this, NAVs are usually declared after market closing hours once a day.
As per the regulator SEBI’s guidelines, all mutual funds are required to publish the NAV of their schemes at least once a week and in two leading newspapers.
Note that the NAV is arrived at after deduction of the Expense Ratio of a mutual fund. The expense ratio is the total amount of annual expenses incurred by a mutual fund and it includes the management fee and operating expenses like the registrar and transfer agent fee, marketing and distribution fee, audit fee and custodian fee.
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