Does a lower NAV mean higher returns from mutual funds?

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Many investors look at a mutual fund’s Net Asset Value (NAV) as an indicator of its potential for returns. The general perception is that funds with a lower NAV tend to provide higher returns over time. But is this understanding correct or merely an investing myth? Let’s examine the relationship between NAV and mutual fund returns in detail.

NAV simply reflects the value of assets under management

The NAV or Net Asset Value per unit reflects the value of holdings of a mutual fund scheme on a per unit basis. Mathematically, it is calculated as the total market value of assets owned by the scheme minus liabilities, divided by the number of units outstanding. By definition, NAV represents the present cumulated worth of investor money in a fund.

NAV per unit changes every day as the prices of the underlying securities move up or down. A lower NAV thus means that either the scheme has fallen in value over time or that it is a newer scheme which has not yet accumulated large assets. But lower NAV per se does not mean higher future returns.

Market prices better predictor of returns than NAV

While NAV shows the scheme’s present asset value, current market price is a better indicator of expected returns. Market price reflects investors’ perceptions and demand-supply dynamics. The same scheme can trade at a premium or discount to its NAV. A premium indicates positive market sentiment and potential for superior returns.

For actively managed equity funds, portfolio quality and fund manager skill have greater bearing on future returns than low or high NAV. Passive index-linked funds derive returns from closely tracking their benchmark indices, not NAV. In fact, a higher NAV signifies that the fund has delivered healthy historical returns.

Don’t chase past returns blindly

Some investors select funds with low NAVs presuming they will rise rapidly in future. But past returns do not guarantee future performance. Many poorly managed funds witness consistent NAV erosion due to weak stock selection. Their lower NAVs simply reflect accumulated losses over time.

On the flip side, some schemes with relatively higher NAVs may be poised for a turnaround under a new fund manager. Blindly chasing low NAV funds or schemes with top 1-year returns can be risky without analyzing their fundamentals.

Consider portfolio composition and market outlook

Rather than NAV, it is more prudent for investors to assess factors like portfolio structure, sectoral allocation, individual stock holdings and fund management quality while choosing a mutual fund scheme. The market outlook also matters.

In a growing economy, funds investing in high quality mid and small-cap shares may deliver strong returns over long term, regardless of their NAVs. Index funds and ETFs with higher NAVs but tracking indices with upside potential can also be profitable.

Conclusion

While many investors associate lower NAV with potential for higher mutual fund returns, the reality is more nuanced. NAV is simply a metric reflecting the present cumulated value of investor money in a scheme on a per unit basis. It holds limited relevance for expected future returns. More important factors are the quality of portfolio holdings, fund management track record, market outlook, expense ratios and use of SIPs. Rather than get fixated on low NAVs, investors must take a holistic approach towards mutual fund investment selection.

Therefore, before making any investment, it is prudent to make use of a mutual fund calculator to estimate your earnings.