NFOs (New Fund Offers) launched at an issue price of Rs 10 are perceived to be a good investment opportunity by a large section of mutual fund investors.

Similarly, existing mutual funds with a lower NAV (Net Asset Value) often appeal more to investors. Visitors of Personalfn are aware that neither approach to selecting a mutual fund is right. In this note, we revisit our views on investing based on the NAV.

What is NAV? Simply put, NAV is the sum total of all the assets of the mutual fund (at market price) less the expenses (fund manager fees, audit fees, registration fees among others); divide this by the number of units and you arrive at the NAV per unit of the mutual fund. An illustration should help us better understand the same.

So when you wish to invest in a mutual fund, you invest in it at its existing NAV (adjusted for the entry load), i.e. you buy the units at a price (i.e. NAV), the calculation of which is based on the current market price of all the assets that the mutual fund owns. In other words, the NAV represents the fund's intrinsic worth.

In case of the stock market, however, the stock price of a company is usually different from its intrinsic worth, or what is called the book value of the share. The stock price could be higher (premium) or lower (discount) as compared to the book value of the company.

A relatively lower share price would, other things being positive, make it an attractive purchase (as the share seems undervalued). The reason for such a 'mis-pricing' could be that investors evaluate the company's future profitability and suitably pay a higher or lower price as compared to its book value. This does not hold true for open-ended mutual funds � they always, always, trade at their book value; so you never buy cheap or expensive in that sense.

The following illustration will clearly establish the irrelevance of NAV while making an investment decision.

Franklin Prima Plus with an NAV of Rs 146.17 (second highest NAV in our sample) clocked a growth of 43.57% over 1-Yr and is the top performer in the segment. Pru ICICI Power with a much lower NAV of Rs 84.51 has clocked a return of 38.67%.

Kotak 30 with a lowest NAV of Rs 72.06 has clocked a return of 36.54% and performed better then HDFC Equity which has the highest NAV of Rs 153.79 but recorded an NAV appreciation of 35.50%, which is the lowest in our sample. This table clearly indicates that there is no correlation between the NAV and the performance of the mutual fund.

It is evident that the fund's current NAV and its expected performance are unrelated and therefore making an investment decision based on the NAV would be misguided. As an investor you need to consider factors like your own risk profile, the fund's management style and performance.

1. Risk profile

Investors have a risk profile that dictates how much risk they can take on to achieve their investment objective. In this backdrop, they must identify mutual funds that can help them meet their investment objectives at the desired risk level.

For instance, some equity funds adhere to the growth style of investment (aggressively managed funds), while others follow the value style of investment (conservatively managed funds). So it is important for investors to select a fund that takes on risk in line with their own risk appetite.

2. Fund management style

Fund houses have varying fund management styles and processes. Some pursue the individualistic style, where the fund manager rather than the investment process plays a dominant role in the investment process. As opposed to this, there are fund houses that pursue a team-based investment approach where the investment process holds sway over the individual.

Our preference is for the team-based style of investing since it is more stable and the mutual fund (and its investors) is not over-dependent on an individual.

3. Mutual fund performance

It is imperative for investors to evaluate a mutual fund on parameters related to risk like Standard Deviation and Sharpe Ratio as also NAV appreciation. The risk parameters evaluate the volatility in performance (Standard Deviation) and returns generated by the fund per unit of risk borne (Sharpe Ratio).

The best deal for an investor will come from a mutual fund that has higher NAV appreciation and Sharpe Ratio and lower Standard Deviation.

Hopefully, we have resolved the debate on the NAV and have given the investor more relevant points to inquire about before considering investing in a mutual fund. So the next time your mutual fund distributor advances the low NAV or Rs 10 NAV argument, demand a detailed analysis of the mutual fund based on the parameters we have listed.

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