How does mutual fund NAV affect performance of a fund?

There were two recent comments that prompted me to write this post, and both had to do with mutual fund NAV (Net Asset Value), and how they impact the performance of a fund.

The truth is that mutual fund NAVs have no impact on the performance of a mutual fund, and you should ignore the NAV while making a decision to buy a mutual fund, and it shouldn’t figure in your decision process at all.

One reader asked me if the NAV and performance of a fund are inversely related, and I think that question has its roots in listening to people touting benefits of investing in a mutual fund NFO, and getting a mutual fund at a ten rupee NAV.

In reality, there is no relationship between the NAV and performance of a mutual fund. The fund’s NAV will have absolutely no bearing on how it’s going to perform in the future or how it has performed in the past.

The second comment was about the relationship between a dividend payout and the NAV of a mutual fund, and even that doesn’t have any effect on performance.

The NAV of a mutual fund will adjust according to the dividend payment, but that doesn’t mean you stand to gain or lose anything based on when you choose to buy the mutual fund.

Let’s take an example to understand this. Suppose you want to start up a mutual fund of your own, and give your family members a chance to invest with you.

You go ahead and shoot out an email to all family members who you think are interested in it, and ask them how much money they are going to invest with you.

Being as smart as you are – you get a lot of responses from your family members, and at the end of your subscription period you get the following sums:

  • Rs. 500,000
  • $10,000

At an exchange rate of 45 rupees to a dollar you convert your 10,000 USD and see that you have Rs. 450,000. So, now your total assets under management are Rs. 9,50,000.

You send out a letter to all your subscribers with the information that the fund has collected Rs. 950,000 and you will send them a quarterly report of your progress.

At the end of the 3 months, you see that your investments have grown smartly, and that you have grown the money to 10,45,000.

Most of your subscribers are happy, but the cousin in US who invested in your fund says that he can’t really understand if you did good or bad, and needs a simple way to compare your performance with the Dow.

You tell him that the fund made 10% in that quarter, and the Dow gained by 3%, and add that from the next statement onwards you are going to send a percentage gain along with the funds under management as well.

Time goes by, and you forget to wish your uncle on his 50th birthday. He does what any loving uncle would do – withdraw his Rs. 50,000 investment from your fund to teach you a lesson. Ouch.

You are the honest nephew, so you tell your uncle that his original investment grew by 10% in the 3 months you handled it so you hand him over a check of Rs. 55,000.

The market remains stagnant in the next quarter, and the fund doesn’t move at all. You shoot an email to your readers telling them that the fund value is now at 9,90,000 and this quarter has been no profit no loss for it.

You get a barrage of emails the next morning from your subscribers who ask you what kind of a scammy outfit you’re running since the value came down from 10,45,000 last quarter to 9,90,000 this quarter, and you saw no loss at all?

You are at a loss on what to do, and decide to call up your good friend Loney who tells you that you need to split up the fund into units, and assign a NAV to the fund. Then tell each of your subscribers how many units they own based on their initial investment, and declare the NAV every quarter instead of declaring the total assets under management. The NAV is not impacted by redemption or new investment, and your current subscribers will better understand your fund performance.

Aha – so now you know why you need that blasted NAV in the first place.

Now, the next question is what to base it on.

You decide that you are going to go the extra mile and make it really easy for your US subscribers to compare your fund’s performance with the DOW and make one unit of your fund equivalent to one unit of the DOW!

You see that the Dow closed at 12,391.25 on February 18th, and decide that one unit of your fund will also represent that sum.

So you divide the initial investment of Rs. 950,000 with 12,391.25 and arrive at 76.67 units. In this case the NAV of 1 unit of your fund is equal to 12,391.25 at the start, and you have 76.67 units in your fund.

You then tell each of your subscribers how many units they own based on how much money they invested with you. When your aunt sees your email about one unit having a NAV of Rs. 12,391.25 she flips out and calls you asking what’s this DOW, and why should she care about it.

After listening to your explanation she understands what you’re doing but wants you to compare your performance to gold instead of DOW because everyone “knows” gold is the next big thing, and you should at least better that.

You try to reason with her, but when she threatens to complain to your mom you go back home, and see that one gram of gold is about Rs. 2,000, so based on that you say that one unit of your mutual fund will be Rs. 2,000 as well, and the total units will now be 450 instead of the earlier 76.67 based on the initial corpus with you.

You draft the email informing subscribers of this change, but before hitting the send button decide to take a second opinion from your brother in Delhi.

When you call him up and tell him about the Rs. 2,000 NAV – he is livid. He hadn’t read your earlier email, and it’s good that he hadn’t because the only reason he invested in your mutual fund was to get a 10 rupee NAV!

What’s the point of investing with you if you give him such an expensive NAV? He demands you to give him a 10 rupee NAV immediately.

You are at the verge of going insane now, and call me up to ask me what you should do. Unfortunately I’m too busy sending people their infrastructure bond statements and doing the needful so I ask you to call up my buddy Shiv who is an adviser.

Shiv tells you to take it easy and keep the NAV at Rs. 10 and placate everyone. It doesn’t matter what the NAV is anyway, it’s just a number you pull out from a hat. This way at least everyone will be happy.

You take this sound advice, and shoot out an email the next day saying that the initial NAV was Rs. 10, and that the fund had 95,000 units, and tell everyone their units individually as well.

You wait for angry emails, but no one replies – no news is good news you decide, and smile for the first time wondering how easy it is to pull out any NAV from your hat, and get everyone all riled up for nothing.

You can make up any NAV you want at the start of the fund, it doesn’t matter if it’s 10 or 10,000, so ignore NAVs while making your investing decision.

45 thoughts on “How does mutual fund NAV affect performance of a fund?”

  1. First of ALL thanks for clearing the doubt so lucidly that leave no scope for confusion and doubt all round d world from america to byculla
    You can also start a commedy channel to explain financial problems
    I m sure u have put up a lot of efforts congrats Manshu
    I must say ur efforts has benifitted many like me

  2. hi,

    We are all immensely benefited by your hard work. Please do continue in this manner :D.However since we are given reports based on NAV change and performance percentage then how do we get a realistic idea of the actual change in our holdings ???


    1. Thanks Vinay. NAV is still useful in evaluating fund performance from one time period to another and you can look at it to see how well your funds have performed. But that alone is not a good indicator to see whether you should have buy a MF or not, specially if you are being sold saying that it is a ten rupee NAV or other nonsense like that.

  3. Hi,

    This was an extremely informative post. Your hardwork is of immense benefit to us. Please do continue in this manner :D. However I am still unclear on one issue. How do we really measure our person profit/loss ? Since we are only informed of our NAV and the performance of the fund as a whole. So how do we know the real change in our holding ??


  4. that uncle thing had me rolling on the floor lol, beautiful imagery man!
    would like to see some elborate stuff simplified in the same manner on arbitrage funds!
    ps-ever tried poetry?

  5. firstly its a nice explanation.
    like a kid i read the story

    pls explain to me how to track performance of a particular fund
    also wat should be the asset size of a particular fund.
    i got to know some magic figure like 800million for small, 3billion for mid nd $9 billion for large cap MF, do u agree??

    1. You can track by creating a portfolio on sites like Moneysights or Moneycontrol or something, or if you buy from a site that allows you to see a portfolio like ICICI Direct, you can track it there as well.

      While I don’t completely understand the context of your fund size question – I don’t think there is a magic number at all.

      1. hi

        by assest size i mean the net asset the fund hold like in hdfc top 200 holds rs.10k crore as its asset.
        bcoz i read in a blog saying high assets of a fund results in a average performance

        1. I think what the blog meant was that as fund size increases it becomes harder to generate the same percentage return as it is in a smaller fund, but I don’t think you need to keep the fund size as a parameter under consideration because most big funds in India have given good returns, and in fact some of the better funds are big as well.

    1. Thanks Mohini – this is the second comment on this post after a long time so I’m wondering if it got shared somewhere today or what. Did you end up on this post from Facebook or how did you find it?

  6. Manshu,Excellent post.
    You have a great knowledge in finance…
    I would like to know more about you…am not sure if that info is available somewhere else too…
    And what was your motivation for this blog…By the way I too had brokers coming to me and selling mf units based on NAV…

    1. Thanks Kapil – you’re too kind – I’m sure there are millions of people much much better versed with the world of finance than myself, and I’m sure there are a few commenters on OneMint itself who are more knowledgeable than I am.

      I’m just a regular guy with what I think is a useful hobby ๐Ÿ™‚

  7. Hi Manshu

    That was very well written. I wanted to share one personal experience of mine.

    A few months back, in August 2010 (the last month before the new ULIP regulations kicked in), I had to go to a private Bank for some enquiry. I met a relative of mine there. (I didn’t know that he worked there). We had a small chat and suddenly, he pulled up a pamplet of XXXX yyyyyyyy life insurance and put in before me. There were many arguments put-forth by him during the course of next 30 minutes.
    1. The returns from ULIPs are going to decrease once the new ULIP regulations come into force in september.
    2. The NAV of a particular fund is now very less just about Rs.5.8/- and odd and so you will get more number of units. There was a correction around that time and once the market turns positive, the NAV would easily jump to Rs.22/- by mid-october 2010.
    3. The promoting bank guarantees such high returns.
    4. I personally have invested Rs.1,00,000/- in that particular ULIP scheme.
    and so on…

    I didn’t know what to say to him.

    1. This is really sad, and the fact that he was a relative makes it even worse. Did you tell him that you know what the changes entail and how they will impact his commission or did you feel that it will embarrass him too much?

      1. As you pointed out, since it will embarrass him too much, I let go of him. He wouldn’t have suspected that I would have known the ABC of finance since I didn’t study commerce or economics even at Junior college level. I just let him know that NAV is not connected to BMI and hence will not help in greater agility in value and 5.8 NAV cannot change to 22 NAV in a matter of three months.
        I really felt sorry for investors, financially not literate, who fell into the traps of these guys, unknowingly! and unwittingly!
        I believe that the incentive structure is the root cause of all sorts of mis-selling. They need a reason to sell. Any investor will be curious if you say
        You will get 500 units for Rs.5000/- that you pay during the NFO.
        Investor : I want to invest Rs.15,000/-
        Advisor : This fund is declaring a dividend of Rs.6/- today. Its NAV is Rs.24/-. So, if you invest Rs.20,000/- today, you will get Rs.5000/- as dividend by next week. (Un-necessary fund transfer charges for the RTA)
        The JM Basic fund has an NAV of Rs.9/- only. Invest Rs.18000/- and get 2000 units. (I donot know why any would would want to invest in this JM Basic fund. This fund still has a corpus of around 350 crores while Quantum Long-term equity fund has a corpus of just around 60 crores.)
        Invest in JM Agri & Infra fund. Agriculture and Infrastructure are the two major themes to look out for. (as many investors of this fund found out!@! I read somwhere! JM stands for Jeopardize your Money)

        1. Only in last few months where I have been exposed to more and more comments from readers have I understood how much bad advice is floating out there.

          No one in our family ever bought mutual funds or insurance based on advice, and I’ve been managing my money on my own, so I never had occasion to interact with financial intermediaries, and the few brokers that I did interact with in my early days were all honest good people.

          As a result I hadn’t realized how hard it is for regular folks to get decent advice, but the type of questions I see on OM really shows me how the odds are stacked against most people who don’t already have a grounding in finance, and are not looking to understand this stuff themselves. The biggest thing I’d like to tell people is that you’re on your own fellows – don’t waste time asking for “expected returns” and listing gains, and things of that nature.

          1. RMs at banks do not necessarily want to mis-sell intentionally. He is miss-selling out of ignorance or compulsion. Ironically these guys themselves may not be aware of the details. You ask a few question and he will stare at your face or rush to his senior. An RM is simply thrust upon him a product and a monthly target. He is underpressure to perform, how can he be thoughtful of investor’s interests or needs.

            1. Exactly! You are absolutely right. And this is exactly what should change.

              The whole financial sector in India was pioneered by Life Insurance Corporation of India.
              1. India was an under-insured country
              2. LIC wanted Indians to be better insured.
              3. This is where everything went wrong. Instead of trying to create an awareness on the benefits and needs of insurance, it chose the other path. To Link insurance with investment and try to sell policies as investment avenues.
              4. It also empanelled advisors and had a loaded commission structure.
              5. When the financial sector developed and new products entered the market. They are emulated the successful LIC story.

              How else could this have been
              1. LIC could have gone on to create awareness and the need to have exhaustive insurance cover.
              2. It could have got special cover over and above 80C limit by taking the issue to the government that India is an under-insured company. This limit could be used only for term insurance cover.
              3. I would like to sincerely appreciate M/S Aegon religare Insurance because that is the only insurance company that has an advertisement for a term plan. Everyone should watch the K.I.L.B. ad. This is the most sincere advt. I have ever seen.
              4. India could even have gone to financial advisory if LIC hadn’t made the first mistake.
              5. People can go to these financial advisors and get an advice. It is just like going to a medical practitioner. You go to him. Tell your financial goals and your financial status and he gives you a roadmap. You pay for the advice and anything went wrong you can go directly to him because you have paid him for advice directly. (In the embedded load structure, that is not possible.)
              6. Had such a thing happened, it could have been better for the financial sector in India.
              7. There could even be a nation-wide test for the empanelment of these advisors.
              8. But, none of these things will ever happen.

      1. You bet! I always do and always have a hard-time explaining investors, specially new entrants to the MF arena.
        I call NAV “No Added Value”! It should never be considered during investment decision process.
        You guessed right! I am.

  8. Yes this is one of the most common myth I come across. People have commented me several times that reliance vision or hdfc top 200 won’t perform good any more because they are already that expensive. What people don’t understand is MFs are not clothes. ๐Ÿ™‚

      1. Manshu, I just hit upon this website recently to get some insight on finance. This is an amazing piece of info that you’ve written. well done. I am at a loss on where to invest now. I am basically an NRE and had parked all my money abroad, 4 months back, my advisor told me that the indian market is down , so push all your money to India and invest it in equity market,which I did. To my utter dissappointment, rupee weakened and dollar became stronger and worst my investments also went down. So i made a notional loss , a big sum indeed ๐Ÿ™ had i waited to transfer money, I would have atleast gained on my exchange rate. I dont know what advise you’re going to give me, but I was wondering if there is any time when currency movement can be predicted. where do u think i should also invest now

        1. I’m sorry to hear about your loss and I’m afraid I will have to disappoint you further because I don’t give any personal recommendations or advice on this site. It’s just not practical to do that efficiently or honestly. I don’t know anything about you, and it’s just not possible to lend the seriousness that these discussions need in the comments section of a blog. Sorry and all the best.

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