Avoid the pitfalls: why buying low NAV funds is not a strategy

The risks and drawbacks of investing in low NAV funds

It is quite common to see mutual fund investors opting for funds with lower NAV. The logic in many (albeit erroneously) is that a fund with a lower NAV is more attractively priced. For instance, the general belief is that a fund with a NAV of Rs22 is better than a fund with a NAV of Rs85. However, such a perception can force you to make sub-optimal decisions. Remember, the NAV just reflects the value of the fund per unit. Whether you buy the fund with a NAV of Rs22 or Rs85, your performance from here on will depend on how the asset class performs and your fund manager does. Let us quickly dwell on NAVs a bit more. 

Table of Contents

1. The risks and drawbacks of investing in low NAV funds
2. What is mutual fund NAV all about?
3. Why buying low NAV funds is a bad strategy?

What is mutual fund NAV all about?

Net asset value (NAV) of a fund is the price at which you buy the fund and represents what the value of the fund assets are worth. For instance, if you bought a fund scheme at a NAV of Rs10 and it is up to Rs12 in 1 year, then it is a 20% return. It is essential to remember that the NAV is slightly different from stock price. Stock price represents the present and future prospects of the company, which is why P/E ratio assumes importance. However, in the case of NAV, it represents the market valuation of the fund scheme. 

Mutual funds have costs, so these costs are debited to the fund NAV in the form of total expense ratio (TER) and debited on a daily basis. 

NAV of a Fund = (Market Value of stocks – Total Expense Ratio) / No. of units issued

The TER (total expense ratio) includes costs like brokerage expenses, administrative expenses, registrar fees, statutory charges, marketing and distribution costs etc. These are charged on an annual basis but apportioned and debited on a daily basis. 

Why buying low NAV funds is a bad strategy?

A lower NAV or higher NAV has little relevance to the attractiveness of the fund. What matters are the CAGR returns, portfolio quality and fund manager quality?

• The NAV number is not too material, to begin with. Whether you hold 1,000 units of Rs.12 NAV or 100 units of Rs120 NAV is immaterial. The second fund may give higher returns than the first fund if the fund portfolio is good and the quality of fund management is better. If you focus on lower NAVs you miss the real story. 
  
   
• Another such NAV myth pertains to Direct Plans versus regular plans. Should you prefer a Regular Plan over Direct Plan due to lower NAV? The NAV of the regular plan is lower because the loading of market costs is higher and not because it is more attractive. Your decision on a regular plan versus a direct plan must be based on whether you need expert guidance or you can manage investment decisions independently. 
  
   
• Is it true that fund with a lower NAV is more nimble-footed? Not at all! NAV has nothing to do with how nimble-footed the fund is. For instance, a fund may have a lower NAV because it started much later during the bull rally. Alternatively, it may have a lower NAV because of more units. These do not determine the attractiveness of the fund. 
  
   
• The performance of the funds will depend on how the corpus is managed by the fund manager and the quality of the portfolio. It is irrelevant whether the NAV of the fund is higher or lower. You must look at how the fund has performed in the past; more than returns look at risk and consistency. But size of the NAV is the lease important thing. 
  
   
• There is something called the dividend size myth. The general belief is that 20% dividend on a Fund with a face value of Rs.100 is more than 20% dividend on a fund with a face value of Rs.10. That is a classic value myth. Dividends are paid off your NAV and deplete the fund value. When 20% dividend is declared by the fund, Rs100 NAV becomes Rs80 and Rs10 NAV becomes Rs8. In percentage terms, the partial liquidation impact on both the portfolios is the same. 

The point is that the level of the NAV does not really matter in your fund choice decision. Instead, focus on the composition of the fund portfolio and how well your fund manager is able to delivery risk-adjusted returns.