Unit Trusts and the net asset value

Fund NAVS are similar to those of stocks, but there are several important differences to be aware of

Morningstar 12 November, 2012 | 1:00PM

In the previous ‘Investing 101’ article, we touched briefly on the unit trust’s net asset value (NAV). NAVs are similar to stock prices since both represent the price of one share (or unit) of an investment. Both appear in newspapers and on financial Web sites.

Calculating the NAV

A unit trust calculates its NAV by adding up the current value of all the stocks, bonds, and other securities (including cash) in its portfolio, subtracting out certain expenses of running the fund (e.g. the manager's salary, custodial fees, and other operating expenses) and then dividing that figure by the fund's total number of units. For example, a fund with 500,000 units that owns R9 million in stocks and R1 million in cash has an NAV of R20.

(10 000 000/500 000 = 20)

So Alike But So Very Different

While stock prices and NAVs have much in common there are five important differences between the two.

Difference One. Stock prices change throughout the trading day, but the NAV of a typical unit trust is calculated only at the end of each day based on the value of its underlying holdings at the time the market closes. When you purchase a unit trust, you buy units at the NAV as of that day's close. As a result, you don't necessarily know the exact NAV of the fund at the time you put in your order to buy or sell. If you place an order early in a given day, you're likely to get that day's closing price for the fund. If you make your order later in the day or after trading has ended, you'll get the following day's closing price.

Difference Two. Stock investors typically specify how many shares they'd like to buy, and buy shares of a given stock in even lots, such as 50 shares of MTN shares or Standard Bank. By contrast, most fund investors purchase funds in rand amounts rather than share amounts. As we noted in a previous article, fund companies willingly issue fractional shares. For example, if you have R1000 that you'd like to put into a fund with an NAV of R118.74, you'll get exactly 8.42 units.

Difference Three. Stocks have a fixed number of shares available. To change its number of shares, a company can either issue new shares or buy back its own shares in the market. By contrast, unit trusts generally have an unlimited number of units, and the number changes on a daily basis, depending on how many units investors buy and sell that day.

Difference Four. You can estimate whether a stock is a bargain or not by comparing its current price to what you consider its "fair value" price, based on your projection for the firm’s ability to generate earnings. With unit trusts, however, the NAV is the sum of the current value of the fund's underlying holdings. But attempting to identify whether the unit trust’s portfolio is a bargain, while theoretically possible, would be a cumbersome process, particularly when you consider that many funds hold well more than 100 stocks or bonds.

Difference Five. You can often use changes in a stock's price to gauge how well a stock is performing. Unit trusts, however, distribute any income or capital gains they realize to shareholders as dividends, which, in turn, causes their NAVs to fluctuate. Unless you account for such distributions, you could be underestimating a fund's actual performance by looking solely at its NAV. To accurately gauge a fund's performance, you need to examine its total return, which takes into account both the appreciation of the fund's holdings as well as any distributions the fund has paid out. (We'll explore this topic in our next ‘Investing 101’ lesson.) Thankfully, most financial institutions produce reports for their clients that details a fund’s total return over various time periods.

Uses of NAV

After learning a bit more about NAVs, you may be thinking, "What the heck can I use NAV for?" Well, NAVs do provide you with a tally of what your investment is worth each day. And because funds calculate daily NAVs, investors can buy and sell each day. Daily access to NAVs also reassures you that your investment is being watched over, valued, and reported on.

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