Net Asset Value – NAV

What Is Net Asset Value – NAV?

The net asset value (NAV) represents the net value of an entity and is calculated as the total value of the entity’s assets minus the total value of its liabilities. Most commonly used in the context of a mutual fund or an exchange-traded fund (ETF), the NAV represents the per share/unit price of the fund on a specific date or time. NAV is the price at which the shares/units of the funds registered with the U.S. Securities and Exchange Commission (SEC) are traded (invested or redeemed).1

Net asset value is commonly used to identify potential investment opportunities within mutual funds, ETFs or indexes. One could also use net asset value to view the holdings in their own portfolio. To invest in any of the aforementioned assets, an investment account would be needed.

Understanding Net Asset Value

Theoretically, any suitable business entity or financial product that deals with the accounting concepts of assets and liabilities can have a NAV. In the context of companies and business entities, the difference between the assets and the liabilities is known as the net assets or the net worth or the capital of the company. The term NAV has gained popularity in relation to the fund valuation and pricing, which is arrived at by dividing the difference between assets and liabilities by the number of shares/units held by the investors. The fund’s NAV thereby represents a “per-share” value of the fund, which makes it easier to be used for valuing and transacting in the fund shares.

It is often the case that NAV is close to or equal to the book value of a business. Companies considered to have high growth prospects are traditionally valued more than NAV might suggest. NAV is most frequently compared to market capitalization to find undervalued or overvalued investments. There are also several financial ratios that use multiples of NAV or enterprise value for analysis.

The Formula for a Fund's Net Asset Value

The formula for a mutual fund's NAV calculation is straightforward:

NAV = (Assets - Liabilities) / Total number of outstanding shares

The correct qualifying items should be included for the assets and liabilities of a fund.

NAV and Mutual Funds

A fund works by collecting money from a large number of investors. It then uses the collected capital to invest in a variety of stocks and other financial securities that fit the investment objective of the fund. Each investor gets a specified number of shares in proportion to their invested amount, and they are free to sell (redeem the value of) their fund shares at a later date and pocket the profit/loss. Since regular buying and selling (investment and redemption) of fund shares start after the launch of the fund, a mechanism is required to price the shares of the fund. This pricing mechanism is based on NAV; ergo, when a mutual fund's NAVPS updates, so too does its price.

Unlike a stock whose price changes with every passing second, mutual funds don’t trade in real-time. Instead, mutual funds are priced based on the end of the day methodology based on their assets and liabilities.

The assets of a mutual fund include the total market value of the fund's investments, cash and cash equivalents, receivables and accrued income. The market value of the fund is computed once per day based on the closing prices of the securities held in the fund's portfolio. Since a fund may have a certain amount of capital in the form of cash and liquid assets, that portion is accounted for under the cash and cash equivalents heading. Receivables include items such as dividend or interest payments applicable on that day, while accrued income refers to money that is earned by a fund but yet to be received. The sum of all these items and any of their qualifying variants constitute the fund’s assets.

The liabilities of a mutual fund typically include money owed to the lending banks, pending payments and a variety of charges and fees owed to various associated entities. Additionally, a fund may have foreign liabilities that may be the shares issued to non-residents, income or dividend for which payments are pending to non-residents, and sale proceeds pending repatriation. All such outflows may be classified as long-term and short-term liabilities, depending upon the payment horizon. The liabilities of a fund also include accrued expenses, like staff salaries, utilities, operating expenses, management expenses, distribution and marketing expenses, transfer agent fees, custodian and audit fees, and other operational expenses.

To compute the NAV for a particular day, all these various items falling under assets and liabilities are taken as of the end of a particular business day.

NAV for Exchange Traded Funds

Because ETFs and closed-end funds trade like stocks on exchanges, their shares trade at a market value that can be a few dollars/cents above (trading at a premium) or below (trading at a discount) the actual NAV. This allows for profitable trading opportunities to active ETF traders who can spot and encash on such opportunities in time. Similar to mutual funds, ETFs also calculate their NAV daily at the close of the market for reporting purposes. Additionally, they also calculate and disseminate intra-day NAV multiple times per minute in real-time.

NAV and Trade Timelines

It is important to note that while NAV is computed and reported as of a particular business date, all of the buys and sell orders for mutual funds are processed based on the cutoff time at the NAV of the trade date. For instance, if the regulators mandate a cutoff time of 1:30 p.m., then buy and sell orders received before 1:30 p.m. will be executed at the NAV of that particular date. Any orders received after the cutoff time will be processed based on the NAV of the next business day.

Measuring Investment Performance

Fund investors often try to assess the performance of a mutual fund based on their NAV differentials between two dates. For instance, one may likely compare the NAV on January 1 to the NAV on December 31, and see the difference in the two values as a gauge to fund’s performance. However, changes in NAV between two dates aren’t the best representations of mutual fund performance.

Mutual funds usually pay out virtually all of their income (like dividends and interest earned) to its shareholders. Additionally, mutual funds are also obligated to distribute the accumulated realized capital gains to the shareholders.2 A capital gain occurs on any security that is sold for a price higher than the purchase price that was paid for it. Since these two components, income and gains, are regularly paid out, the NAV decreases accordingly. Therefore, though a mutual fund investor gains such intermediate income and returns, they are not reflected in the absolute NAV values when compared between two dates.

One of the best possible measures of mutual fund performance is the annual total return, which is the actual rate of return of an investment or a pool of investments over a given evaluation period. Investors and analysts also look at compounded annual growth rate (CAGR), which represents the mean annual growth rate of an investment over a specified period of time longer than one year provided all intermediate payments for income and gains are accounted for.

Example of NAV Calculation

Assume that a mutual fund has $100 million worth of total investments in different securities, which is calculated based on the day's closing prices for each individual asset. It also has $7 million of cash and cash equivalents on hand, as well $4 million in total receivables. Accrued income for the day is $75,000. The fund has $13 million in short-term liabilities and $2 million in long-term liabilities. Accrued expenses for the day are $10,000. The fund has 5 million shares outstanding. Using the above formula, the NAV is calculated as:

NAV = [($100,000,000 + $7,000,000 + $4,000,000 + $75,000) - ($13,000,000 + $2,000,000 + $10,000)] / 5,000,000 = ($111,075,000 - $15,010,000) / 5,000,000 = $19.21