Understanding Mutual Fund NAV and Why Low Does Not Mean Cheap

When browsing a list of mutual funds, one of the first numbers visible next to any scheme name is its Net Asset Value, or NAV.

For one fund, that number might be ₹15. For another fund in the very same category, it might be ₹150 or even ₹800.

In everyday life, a lower price tag usually signals a bargain. A kilogram of apples priced at ₹80 feels cheaper than one priced at ₹160. Many savers carry that retail instinct directly into mutual funds, assuming that a scheme with a low NAV gives them more for their money, or leaves more room for future growth.

That instinct is entirely natural, but in mutual funds, it does not apply. To see why, one has to look at how that number is built.

How a fund calculates its NAV

A mutual fund is essentially a common pool of money contributed by thousands of individual savers. An asset management company collects this money and uses it to purchase a portfolio of securities, such as company shares, government bonds, or commercial paper.

To keep track of who owns what fraction of this collective pool, the fund is divided into equal portions called units. When someone invests ₹10,000, they are allocated a specific number of units corresponding to their contribution.

The Net Asset Value is simply the rupee value of one single unit of that fund on a given day. It is determined through a standard accounting formula mandated by the Securities and Exchange Board of India (SEBI):

$$\text{NAV} = \frac{\text{Total Assets} - \text{Total Liabilities}}{\text{Total Number of Outstanding Units}}$$

Here is how those components work in practice:

• Total Assets: At the end of every trading day, the fund calculates the current market price of every single stock or bond it holds. It adds any cash sitting in the fund's bank account, along with any accrued interest or dividends owed to the fund.
• Total Liabilities: The fund deducts its operational costs. This includes management fees, registrar expenses, custodian fees, and marketing charges. These collective costs are known as the Total Expense Ratio (TER), and a tiny fraction of this annual fee is accrued and deducted every single day.
• Outstanding Units: This is the total number of units currently held by all unitholders combined.

Under SEBI guidelines, mutual funds calculate this figure every business day after market trading closes. By late evening, the day's closing NAV is published on the Association of Mutual Funds in India (AMFI) website and the fund house's portal.

Because market prices of the underlying shares and bonds move up and down, the NAV moves up and down along with them.

Why a lower NAV is not a discount

When buying shares of an individual company, price can sometimes be weighed against earnings to assess whether the stock is expensive or undervalued. But a mutual fund unit is not a company. A mutual fund unit is merely an internal measuring unit for a basket of assets.

A fund with a low NAV is not selling its underlying stocks at a discount. It simply started more recently, or has accumulated fewer years of compounding, or has had more units issued relative to its asset size.

Consider a simple physical analogy. Imagine a gold bar weighing 100 grams, valued at ₹7,00,000.

If one jeweller slices that bar into 10 equal pieces, each piece weighs 10 grams and costs ₹70,000. If another jeweller slices an identical 100-gram bar into 100 equal pieces, each piece weighs 1 gram and costs ₹7,000.

The ₹7,000 piece is not "cheaper" than the ₹70,000 piece. It does not offer a better bargain, nor will it produce a higher return if the global price of gold rises. It is simply a smaller slice of the same underlying asset.

In the same way, whether a fund unit is priced at ₹10 or ₹100 tells an investor nothing about whether the investment is economical.

Running the numbers side by side

To make this concrete, imagine two distinct mutual fund schemes: Scheme A and Scheme B.

Both schemes happen to hold an identical collection of securities in identical proportions. However, Scheme A was launched very recently and has an NAV of ₹10. Scheme B was launched fifteen years ago and, after years of accumulated market growth, has an NAV of ₹100.

Suppose an investor allocates ₹1,00,000 to Scheme A, and another investor allocates ₹1,00,000 to Scheme B:

• In Scheme A, the investor receives 10,000 units (₹1,00,000 divided by ₹10).
• In Scheme B, the investor receives 1,000 units (₹1,00,000 divided by ₹100).

Now suppose the underlying basket of securities performs well and rises in value by 10% over the subsequent period. (This 10% figure is used solely as an arithmetic assumption to demonstrate the mechanics, not as a forecast or expectation of future performance.)

• The NAV of Scheme A rises by 10%, moving from ₹10 to ₹11.
• The NAV of Scheme B also rises by 10%, moving from ₹100 to ₹110.

Now observe the ending portfolio value for each investor:

• The investor in Scheme A holds 10,000 units valued at ₹11 each, which equals ₹1,10,000.
• The investor in Scheme B holds 1,000 units valued at ₹110 each, which equals ₹1,10,000.

Both investors earned exactly ₹10,000. Owning more units in Scheme A did not generate an extra rupee of gain. The rate of return was determined entirely by the performance of the underlying holdings, not by the entry NAV.

Similarly, if the underlying market fell by 10%, both investments would decrease to ₹90,000. A lower starting NAV offers no protective cushion against market declines.

What the NAV cannot tell you

Because NAV is just an accounting snapshot, relying on it to judge a fund can lead to several misunderstandings.

First, NAV does not indicate portfolio quality. A scheme with an NAV of ₹12 might hold companies that carry significant debt or face deteriorating business models. A scheme with an NAV of ₹400 might hold resilient, cash-generating businesses. The NAV reveals nothing about the health of those companies.

Second, NAV does not show whether the underlying securities are overvalued. If a fund manager purchases shares at peak valuations during a market bubble, an NAV of ₹10 is just as exposed to a correction as an NAV of ₹500.

Third, an initial NAV of ₹10 during a New Fund Offer (NFO) is not an initial public offering (IPO) discount. In an equity IPO, a company issues fresh equity that may be priced favourably relative to competitors. In a mutual fund NFO, the initial ₹10 is simply an arbitrary starting number for the accounting system. The money collected during an NFO is deployed into existing market securities at prevailing market prices.

The single role of NAV

Net Asset Value has one primary function: it establishes the exact transaction price when entering or exiting a mutual fund.

When putting money into a fund, the applicable NAV determines how many units are credited to the investor's statement. When withdrawing money, the prevailing NAV determines how much cash is deposited into the investor's bank account, subject to applicable exit loads and capital gains taxes.

Beyond that arithmetic function, the absolute level of the NAV is neutral. It is neither expensive when high, nor a bargain when low. What ultimately drives the value of an investment is how the underlying portfolio of stocks or bonds performs over time, minus the ongoing expenses of running the fund.