The Hindu Business Line : Fund Talk

I heard from an intermediary that while investing in mutual funds, the NAV of the fund is irrelevant. As long as the performance of the fund is good, you could buy funds with a high NAV (such as Reliance Growth or Vision). Does this statement hold good? My view is that if the NAV of the fund is low, I can get more units for the same amount of money. More units also means more dividends, as dividends are declared on a per- unit basis. Should one go for high NAV funds?

S. Dinesh

The distributor you have spoken to is absolutely right. The absolute NAV of a fund is not a material factor in your investment decision. As an investor, your focus should be on the returns your investment in an equity fund can generate. The quantum of returns generated by an equity fund depends on the stocks in its portfolio and how they perform over your holding period. The starting NAV of the fund, at which you enter it, does not determine this performance. The NAV of a fund is the market value of the stocks in its portfolio (adjusted for expenses/liabilities) divided by the number of units outstanding.

If Fund A has NAV of Rs 10 per unit, this shows that the stocks in its portfolio are worth Rs 10 (when divided by the number of units issued) at today’s market prices. If the NAV of Fund B is Rs 50, the stocks in its portfolio are worth Rs 50 per unit at today’s prices.

Assuming you decide to invest today, whether you take an exposure to Fund A or Fund B, you will be entering the two equity portfolios at today’s market prices and at today’s Sensex levels. If you invest in Fund A, the returns over the next three years will depend on how the stocks in Fund A’s portfolio fared, relative to Fund B and the broad market.

In practice, equity funds with high NAV have beaten those with a lower NAV through good stock selection. Investors who entered Reliance Vision Fund at an NAV of Rs 65 per unit in September 2004 would have earned a two-fold appreciation on their investment till date, despite the high starting NAV. Funds such as HDFC Equity Fund and Birla Sun Life Equity are among the top ten equity funds ranked by returns, over the past three years.

An investor who stayed away from these funds in September 2004 due to a high absolute NAV (Rs 53 per unit and Rs 61 per unit) would have lost out on an opportunity to more than double his investment over the past three years.

This is not to say that funds with a high absolute NAV will turn out to be top performers or that those with a low NAV will not perform. The above examples have been used to prove that when it comes to an investor’s returns, the investment strategy of the fund and the stock choices and skills of its fund manager are the key factors to be considered and not the NAV of the fund.

As to your question about units, the number of units you get in a fund is irrelevant to your eventual returns from the fund. Assuming you have Rs 10,000 to invest and have to choose between Fund A and Fund B (as above). Your investment in Fund A will fetch you 1,000 units and your investment in Fund B will fetch you just 200 units.

At the end of five years, if both funds have managed a similar 50 per cent return, Fund A’s NAV will be Rs 15 and Fund B’s at Rs 75. Your investment in these funds would be worth Rs 15,000, no matter in which fund you invested (Value of Fund A = 1,000 units @ Rs 15 per unit; Value of Fund B = 200 units @ Rs 75 per unit). This shows that the number of units you receive is immaterial in determining your returns from an equity fund investment.

Finally, to your question about dividends. An equity fund declares dividends out of the profits generated on selling its stocks. If a fund has a surplus of Rs 10 crore and has 1 crore units outstanding, it can declare a dividend of Rs 10 per unit. If the same fund had only half a crore units outstanding, it can declare Rs 20 dividend per unit. The surplus available with the fund for declaring a dividend once again depends on the gains in its portfolio.

Therefore, no matter how many units you hold, the dividends from the fund will ultimately hinge on the performance of the stocks in its portfolio.

You should also note that dividends declared by a mutual fund do not add to your returns as an investor. When an equity fund with an NAV of Rs 50 per unit declares a Rs 10 dividend, the NAV of the fund will decline to Rs 40 after the declaration.

AARATI KRISHNAN

(Queries may be e-mailed to mf@thehindu.co.in, or sent by post to Business Line, 859- 860, Anna Salai, Chennai 600002.)

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