Net asset value – Definition of net asset value

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What is the net asset value (NAV)?

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

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

Key points to remember

  • Net asset value, or net asset value, is equal to the total assets of a fund or company less its liabilities.
  • NAV is commonly used as the calculated share value for a mutual fund, ETF, or closed-end fund.
  • For an investment fund, the net asset value is calculated at the end of each trading day on the basis of the closing prices of the securities in the portfolio. For companies, the net asset value can be considered to be close to its book value.
  • Shares of a company or fund may trade in the market at levels that deviate from its net asset value.

Understanding NAV

Theoretically, any suitable business entity or financial product that deals with the accounting concepts of assets and liabilities can have a net asset value. In the context of corporations and business entities, the difference between assets and liabilities is known as net assets or business equity or capital. The term NAV has gained popularity with respect to fund valuation and price, which is obtained by dividing the difference between assets and liabilities by the number of shares / units held by investors. The fund’s net asset value thus represents a “per share” value of the fund, which facilitates its use for valuation and transactions on the fund’s shares.

Often, the net asset value is close to or equal to the book value of a business. Companies considered to have high growth prospects are traditionally valued more than the net asset value would suggest. Net asset value is most often compared to market capitalization to find investments that are undervalued or overvalued. There are also several financial ratios that use multiples of the NAV or Enterprise Value for analysis.

The formula for the net asset value of a fund

The formula for calculating the net asset value of a mutual fund is simple:

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

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

Net asset value and mutual funds

A fund works by collecting money from a large number of investors. It then uses the raised capital to invest in a variety of stocks and other financial securities that match the fund’s investment objective. Each investor receives a specified number of shares in proportion to the amount invested, and they are free to sell (redeem the value of) their fund shares at a later date and pocket the profit / loss. Since the regular buying and selling (investing and repurchasing) of fund shares begins after the fund is launched, a mechanism is needed to set the price of the fund’s shares. This pricing mechanism is based on NAV. Therefore, when the NAV of a mutual fund is updated, so does its price.

Unlike a stock whose price changes with every passing second, mutual funds do not trade in real time. Instead, mutual funds are valued based on the end of 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, accounts receivable and accrued income. The market value of the fund is calculated once a day on the basis of the closing prices of the securities held in the fund’s portfolio. As a fund may have a certain amount of capital in the form of cash and liquid assets, this part is recognized under the heading cash and cash equivalents. Receivables include items such as dividend or interest payments applicable on that day, while accrued income refers to money earned by a fund but not yet received. The sum of all these elements and any of their qualifying variants constitutes the assets of the fund.

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

To calculate the NAV for a given day, all of these various asset and liability items are taken at the end of a particular business day.

NAV for exchange traded funds

Since ETFs and closed-end funds trade like stocks on the stock exchange, their shares trade at a market value that can be a few dollars / cents above (premium trading) or below (haircut trading). the actual net asset value. This allows profitable trading opportunities for active ETF traders who can spot and cash in on such opportunities on time. Like mutual funds, ETFs also calculate their daily market close net asset value for reporting purposes. In addition, they also calculate and broadcast intra-day NAV several times per minute in real time.

NAV and commercial timelines

It is important to note that even though NAV is calculated and reported on a particular business date, all buy and sell orders for mutual funds are processed based on the cut-off time at NAV of the date of the transaction. For example, if regulators impose a cut-off time of 1:30 p.m., buy and sell orders received before 1:30 p.m. will be executed at the net asset value of that particular date. Any order received after the cut-off time will be processed on the basis of the net asset value of the following business day.

Measuring return on investments

Fund investors often try to assess the performance of a mutual fund based on their differences in net asset value between two dates. For example, one can probably compare the net asset value on January 1 to the net asset value on December 31 and take the difference between the two values ​​as an indicator of the fund’s performance. However, changes in net asset value between two dates are not the best representations of mutual fund performance.

Mutual funds generally pay almost all of their income (such as dividends and interest earned) to their shareholders. In addition, mutual funds are also required to distribute accrued realized capital gains to shareholders.A capital gain occurs on any security sold for more than the purchase price that was paid for it. These two components, income and earnings, being paid regularly, the net asset value decreases accordingly. Therefore, even though a mutual fund investor obtains such intermediate income and returns, they are not reflected in absolute net asset value values ​​when compared between two dates.

One of the best possible measures of mutual fund performance is total annual return, which is the actual rate of return of an investment or group of investments over a given valuation period. Investors and analysts also look at the Compound Annual Growth Rate (CAGR), which represents the average annual growth rate of an investment over a specified period greater than one year, provided that all interim payments for income and gains are taken into account.

Example of calculation of net asset value

Suppose a mutual fund has $ 100 million of total investments in different securities, which are calculated based on the day’s closing prices for each individual asset. It also has $ 7 million in cash and cash equivalents, as well as $ 4 million in total receivables. The accumulated income for the day is $ 75,000. The fund has $ 13 million in current liabilities and $ 2 million in long-term liabilities. Expenses payable for the day are $ 10,000. The fund has 5 million shares outstanding. Using the above formula, NAV is calculated as follows:

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

On the particular day, mutual fund shares will trade at $ 19.21 per share.

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