31st July 2012, 09:47 PM
I had written this article for another site in 2007.
The Net Asset Value is the fund’s share price. The NAV is calculated by dividing the current value of the portfolio by the number of fund units (shares) outstanding.
NAV for most funds is calculated on daily basis and is available in daily financial papers.
Suppose there are three investors in a mutual fund - A, B and C.
A invests 2$.
B invests 3$.
C invests 5$.
Suppose the Mutual Fund company decides to initially issue shares (units) at 1$ each.
Thus initial corpus of the Mutual Fund will be 2+3+5 = 10$.
A will get 2 units.
B will get 3 units.
C will get 5 units.
Now suppose the fund manager invests 3$ in Company 1, 3$ in Company 2 and 4$ in Company 3.
After one year
Value of investment in Company 1 = 5$
Value of investment in Company 2 = 2$
Value of investment in Company 3 = 5$
Thus total value of the mutual fund portfolio = 5+2+5 = 12$.
Now NAV (Net Asset Value) is calculated as
NAV per Share = Current value of Fund Portfolio / Number of Fund Units
= 12$ / 10 Shares = $ 1.2
Thus after one year,
Value of A’s portfolio = NAV of each unit X Number of units held by A = 1.2 X 2 = 2.4 $
Value of B’s portfolio = 3.6 $
Value of C’s portfolio = 6 $
As we can see from the above example, the ABSOLUTE GAIN made by each investor in the mutual fund is proportional to the amount invested initially by him, but in terms of PERCENTAGE all three have gained 20% returns in one year.
Note: NAV may not be a good indicator of a fund’s performance because it does not include the effect of dividends distributed by it every year.
(In US, most mutual funds find it favorable to qualify as a “Regulated Investment Company” under the Internal Revenue Code. This helps them to pass on their incomes and gains to shareholders without having to pay taxes at fund level on dividend and capital gains from sell of securities. Thus “double taxation” is avoided and taxation applies only at shareholder level. To qualify as a “Regulated Investment Company”, the fund must pay out minimum 90% of its gains and income during the tax year, to its shareholders).
Whenever a fund distributes a dividend to its shareholders, its NAV goes down by the same amount. Thus for someone not invested in the fund, the returns may appear lower, if only the NAV appreciation is considered and distributions are not included in the calculations.