Do Mutual Funds With Lower NAVs Give Better Returns?

When it comes to investing in mutual funds, one common question that arises is whether mutual funds with lower Net Asset Values (NAVs) offer better returns. NAV is the per-unit value of a mutual fund, which is calculated by dividing the total assets of the fund by the total number of outstanding units. While NAV is an important factor, it’s essential to understand that lower NAVs do not necessarily equate to higher returns. This article explores the relationship between NAV and returns, clarifying common misconceptions and offering insights for investors.

Understanding NAV (Net Asset Value)

NAV represents the price at which an investor buys or sells units of a mutual fund. The NAV fluctuates based on the value of the assets within the fund, including stocks, bonds, or other securities.

Key Factors That Affect NAV

• 📉 Market Performance: The overall performance of the assets in the fund directly impacts the NAV. If the assets in the portfolio perform well, the NAV will rise, and vice versa.
• 🏦 Inflows and Outflows: The buying and selling activity of investors also influences the NAV, as the fund’s assets are adjusted to meet demand.
• 💼 Fund Management: The skill of the fund manager in selecting profitable assets can lead to a higher NAV over time.

The Misconception: Lower NAV Means Better Returns?

It is a common belief that mutual funds with a lower NAV are a better bargain or will give better returns in the future. However, this assumption is often misleading.

Why Lower NAVs Don’t Always Lead to Better Returns

• 🔍 NAV is Not a Measure of Performance: A lower NAV simply reflects the current market value of the mutual fund’s units. It does not provide any direct indication of the fund’s past performance or future potential.
• 📊 Returns Are Based on the Fund’s Portfolio: The key factor driving returns is the quality and performance of the underlying assets in the fund, not its NAV. Two mutual funds with the same NAV could have vastly different returns based on their portfolios.
• ⚖️ Unit Price Doesn’t Affect the Investment Size: Whether a mutual fund has an NAV of ₹10 or ₹100, the amount invested and the number of units purchased determines your overall stake in the fund. Thus, a lower NAV doesn’t necessarily mean more units or better future performance.

How to Evaluate Mutual Funds for Better Returns

Instead of focusing solely on NAV, investors should consider other key factors when evaluating mutual funds:

1. Fund’s Past Performance

• 📅 Consistency: A mutual fund that has delivered consistent returns over time may offer better potential for long-term growth.
• 💥 Risk-Adjusted Returns: It’s important to assess not just the returns, but the risk taken to achieve those returns. Funds with higher returns but higher volatility may not be suitable for conservative investors.

2. Fund Manager’s Track Record

• 🎓 Experience: A skilled fund manager with a proven track record of making sound investment decisions can significantly impact the returns of the fund.
• 🧑‍💼 Management Style: Look for funds managed by professionals who follow a clear strategy, whether value-based, growth-oriented, or focused on income generation.

3. Expense Ratio

• 💰 Fees and Costs: A lower expense ratio means fewer costs to the investor, which can result in better returns over the long term. Compare the expense ratios of different funds before making a decision.

4. Investment Objective and Risk Profile

• ⚖️ Risk Tolerance: Some funds are designed for high-risk, high-reward strategies, while others focus on safer, more stable returns. Choose a fund that aligns with your risk tolerance and financial goals.
• 🎯 Goal Fit: Ensure that the mutual fund’s objectives align with your own—whether it’s capital appreciation, income generation, or capital preservation.

Case Study: Understanding the Impact of NAV

Let’s compare two mutual funds with different NAVs:

• Fund A: NAV ₹50, invested in a diversified portfolio of large-cap stocks.
• Fund B: NAV ₹5, invested primarily in emerging markets with a high growth potential.

Evaluating the Returns:

• 🏆 Fund A has delivered a consistent 10% annual return for the past 5 years, with moderate risk.
• ⚡ Fund B has shown an average annual return of 15% over the same period but with higher volatility and more risk.

Despite Fund B having a significantly lower NAV, it has higher volatility and risk associated with it. Fund A, on the other hand, is more stable and provides consistent returns.

Key Takeaway:

• 📊 The NAV doesn’t tell you about the fund’s volatility or performance. It’s crucial to assess the underlying assets, past performance, and fund strategy rather than just looking at the NAV figure.

When Can a Lower NAV Be Beneficial?

While a lower NAV doesn’t inherently offer better returns, there are situations where it can be beneficial:

• 💸 Dollar-Cost Averaging: For investors following a dollar-cost averaging strategy, investing in a mutual fund with a lower NAV may allow them to buy more units for the same amount of money. This approach helps reduce the impact of market volatility over time.
• 🔄 Compounding: If a mutual fund with a lower NAV performs well and grows over time, the investor may see substantial returns as the value of their units increases.

Conclusion

The relationship between NAV and mutual fund returns is more complex than simply assuming lower NAVs lead to higher profits. NAV reflects the price of the mutual fund’s units at a given point in time, but the true measure of a fund’s success lies in its underlying assets, management strategy, performance consistency, and risk profile. Investors should focus on these factors when making investment decisions, rather than being influenced by the NAV alone.

In summary, a lower NAV does not guarantee better returns, and investors should conduct thorough research to assess mutual funds based on their goals and risk tolerance. By focusing on the quality of the portfolio and fund performance, you’ll be in a better position to make an informed investment decision.