Should investors avoid funds that have delivered superior performance because their net asset values (NAVs) are no longer cheap? The answer would be a big 'NO.'
There are many investors who have fallen prey to such line of thought - sometimes endorsed by financial journalists - and avoid good performing funds even though their higher NAVs are a reflection of the market's superior performance.
What it means is that some investors select wrong funds to invest in because they are looking at parameters which have no relevance. It is like taking a bus because it is of a particular colour rather than the route one wants to take.
Does it really matter if the fund's NAV is higher or lower? Let us understand what an NAV is. The discussion is about the concept of NAV and not the accounting definition.
A mutual fund is an investment vehicle in which an investor can invest money on any working day. (For the sake of simplicity, we will restrict our discussion to open-ended mutual funds). Investors come in and go out with different amounts and at different times. In such a scenario, how does one keep track of the value of the investment of various different people? This is where "unit" and "NAV" has a role to play.
At any point of time, the value of one's investment can be obtained by multiplying the unit balance with the prevailing NAV. This is the only purpose that NAV and units serve.
Any fund that gets launched starts with some reference value, which is known as face value. An investor investing at the time of launch of the fund would get the units allotted at a value derived from the face value.
Once the allotment happens, on the on-going basis the value of the units is calculated through an accounting formula. The formula is consistent across all the fund houses as prescribed by standard accounting norms and Sebi guidelines. This value is called the NAV.
The NAV may change daily since the value of the securities that the fund has exposure to may change owing to market forces. Thus, two investors entering a fund at two different dates will buy the units at different NAVs.
How many units one gets is thus a function of the amount invested and the prevailing NAV. Once allotted, the unit balance in an investor's account remains constant assuming there is no transaction in the account.
The change in the value of investment will then depend only on the changes in the NAV. As can be seen, having units and NAV makes it easy to calculate the value of one's investment on any given day.
Now comes the question: should one buy funds with low NAVs or avoid funds with high NAVs?
As mentioned, the units allotted would be a function of the amount invested and the prevailing NAV. If the amount invested is higher, more units would be allotted whereas if the NAV is higher, fewer units would be allotted.
For the same amount of investment, one gets fewer units if the NAV is high and vice versa. That is where certain investors avoid funds with high NAV since they would get fewer units.
But since the NAV and unit balance give you the value of investment, a combination of high NAV and fewer units is no different from a combination of low NAV and more units.
The NAV of a fund is not an important criterion at all. In fact, it is irrelevant to consider while selecting a mutual fund.
At the same time, the high NAV may tell a story regarding the relative performance of the fund if you compare two schemes launched together. Since the NAV would be similar and over a period of time, the performance of the funds would reflect in their respective NAVs.
One, however, has to also see how long a fund has been in business since the compounding of the earnings over longer period would also make the NAV higher.
If we look at the last two arguments, there could be a case for actually looking at funds with higher NAV. Invariably; funds with a superior long term track record will have higher NAVs.
So if you are investing money with a professional fund manager, track record is an important criteria to take into account as well.
