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NAV Calculation
Here is a nice article addressing a core component of the fund administrator role: how to calculate a NAV (net asset value). This is useful for fund accountants preparing for roles in NAV calculation in hedge funds and NAV calculation in mutual funds. For more advanced fund accounting training and fund financial reporting training, click on TRAINING above.
WHAT ARE OPEN-ENDED INVESTMENT FUNDS
Open-ended investment funds allow investors invest, or withdraw, funds on a regular basis. Many mutual funds allow investors to do this on a daily basis. In other words, many mutual funds are daily dealing funds. Many hedge funds permit investments and withdrawals monthly. That is, they are monthly dealing funds.
Mutual funds and many hedge funds are unitised. This means that the fund issues shares or units to investors. In order to ascertain the value of a share in the fund, the fund must complete a NAV calculation (net asset valuation). The NAV calculation is a core element in mutual fund accounting and hedge fund accounting.
NAV = Assets less Liabilities
WHAT IS A NAV
A NAV calculation ascertains the fund value as at a point in time. It is the total assets less total liabilities.
Assets are what the fund owns. This includes receivables.
Liabilities are what the fund owes. This includes payables.
Let’s see what is behind each line item in the NAV calculation.
NAV Calculation
NAV Calculation - Equities
This NAV calculation has been done as at the close of business on 31st August. So the market value of the equity portfolio has been calculated using the closing market prices of 31st August. The fund pricing policy determines the type of price used. It is often the last traded price.
NAV Calculation - CFDs
The unrealised gain on open CFD positions is calculated by comparing the closing prices of the underlying asset on 31st August with the price at which the position was opened or reset.
NAV Calculation - Cash
The cash balance is straightforward. It’s simply the cash sitting in the fund’s cash account at the close of business on the 31st August.
NAV Calculation – Unsettled trades
NAV accounting is done on a trade date basis. This fund sold equities on 30th August and the trades settle on 2nd September. This means the fund will pay the cash on 2nd September and the equities will be received into the fund’s custody account on 2nd September. But because we’re fund accounting on a trade date basis, 30th August is the effective date of the transfer of ownership of the equities.
So? The equities sold on 30th August are NOT included in the market value of the equities in the 31st August NAV. But, the cash that will be received on 2nd September IS included in assets as Receivable for Securities Sold.
Similarly, equities purchased on 30th August are included in the market value of the equities in the 31st August NAV. And the cash that will be paid on 2nd September is included in liabilities as Payable for Securities Purchased.
NAV Calculation – Income Receivable
NAV accounting is done on an accruals basis. So income and expenses are recognised in the period to which they relate. This is often different to the point where the cash is actually received or paid.
Regarding dividend income, the fund includes the income on ex-date. The dividend income receivable in the 31st August NAV will probably be received during September. But because we’re fund accounting on an accruals basis, it is included in the 31st August NAV.
NAV Calculation – Currency Forwards
The unrealised loss on open currency forwards positions is calculated by comparing the closing forward rates on 31st August with the rate at which the position was opened.
NAV Calculation – Expenses Payable
As discussed above, NAV accounting is done on an accruals basis. So expenses are recognized in the period to which they relate. As at 31st August the fund recognizes expenses that have been incurred up to that point. The expenses payable amount reflected in the NAV calculation includes, for example, the management fee and the administration fee incurred in respect of the month of August.
NAV Calculation – NAV per share
The total net asset value is € 91,664,830. The number of fund shares in issue as at the 31st August is 11,945,322. So the NAV per share is $7.6737.
NAV Calculation - Partnerships
If the fund is a partnership, no shares or units are issued and the NAV consists of an allocation of fund gains/losses across the partnership capital accounts.
NET ASSET VALUE (NAV) CONCEPT: HOW WE CAN USE IT TO BUILD OUR OWN INVESTMENT PORTFOLIO?
Why I got interested in the concept of Net Asset Value (NAV)? Because it helped me to see my portfolio-building from the eyes of a mutual fund manager.
Generally, I build my savings under several heads (like saving#1, saving#2 etc). Overtime, savings keeps accumulating under each head. When it becomes sufficiently large, I use a part of it and lock them in investments.
So the money that flows into my investment portfolio, is in a staggered way. If the first instalment comes in January, then the next may come in March and so on.
But such staggered in-flow of money into my portfolio gave rise to a unique problem. The problem was, “how to assign the gains/losses to the new influx of money“. I’ll explain it more later. Before that let me tell you how NAV caught my attention.
The Concept of NAV catching my attention…
The problem I was facing led me towards mutual funds. I wanted to know how and why mutual fund schemes use the Net Asset value (NAV) to allot units to investors.
As represented in the above infographics, mutual fund schemes receive funds from investors at different times (shown as savings #1, #2 etc). As mutual fund’s performance is dynamic, it keeps changing with time. There will be some investors who will enter the fund when performance is bearish. Some will enter when bull is strong. How mutual funds takes care of this factor?
When I was thinking over this, I also began to realised the utility of NAV. It not only works as a live price (indicator), but it also justifies ones early and late entry-points into a scheme.
Since then I’ve used the concept of Net Asset Value (NAV) to allot units to myself – to handle my personal portfolio. I try to build my portfolio like a fund manager does for his/her scheme.
It is quite a fun. Moreover, it completely solved my problem of gain/loss assigning (solution is here). But first, let’s learn about my problem.
Here is the problem. Due to inflow of new funds into my portfolio, the gains of existing savings#1 got reduced. Why? Because the unrealised gain which was shown as Rs.2,000 is now proportionately shared by Savings#1 and Savings#2. But actually, savings#2 is not eligible to claim gains in February.
Why Savings #2 is not eligible for proportional gain? Because it has come-in right on the last day of February. All the gains of Rs.2,000 is attributable only to savings#1.
Similarly, had my portfolio showing negative gains of say -Rs.2,000, it would have been unfair for the savings#2 to share the weight of the already accrued losses.
Trade processing Process
https://youtu.be/FXgjH7SUVJA
Let’s see the individual terms indicated in the above NAV formula:
Total Asset: It is basically the sum of market value of all securities included in the portfolio. The securities can be stocks, bonds, cash etc. For securities like stocks, current market value is considered for valuation. It means, when stock price will go up, the NAV of the mutual fund scheme will also go up and vice versa.
Total Expenses: Mutual fund basically works as a money aggregators. They pool-in money from people, and then invest them in lump-sum to buy securities. This is a service that they provide for their subscribers. In turn, they charge a fee. The charges on the fee include, fund management charges, operation costs, distribution expenses, marketing expenses etc.*
Number of Units: Like listed company’s have shares, mutual fund schemes have units. Each unit represents the total asset of the scheme divided into infinitesimal small parts. When we buy a unit, we are actually buying a small portion of the mutual funds asset. Each unit of a scheme is priced at its NAV.
[* P.Note: Generally, mutual fund companies books the expenses on daily basis. It is not as if the total annual expense is booked to the assets on the first day itself. I had to explain this as it took me some time to fetch this know-how from internet 🙂 ]
To solve my problem, what I needed was few units and NAV of my personal portfolio. This will eliminate my problem. But before seeing how NAV & Units solved the problem, let’s know one more thing about NAV’s. Knowing this will eventually help in seeing the solution from a much clearer perspective.
How NAV of NFO (New Fund Offer) is decided?
When a mutual fund scheme is at an NFO stage, its NAV is mandatorily fixed at Rs.10 per unit. At this stage, the fund house takes the job of marketing and distributing the new scheme (NFO) to the public. Depending on the fundamentals of the scheme, its uniqueness, fund house’s brand name, fund managers credentials, marketing, timing of launch etc, people start to pool-in their money.
Suppose the total money collected by the scheme at the NFO stage was say Rs.100 crore. As NAV is fixed at Rs.10/share, it means, total number of units to be created is 10 crore nos (=100/10).
Once the units are created, it needs to be allotted to each investor in proportion to their invested amount. Suppose a person invested Rs.2,500 in the NFO. In this case he will get 250 nos units (=2500/10) at NAV of Rs.10.
Now from this point forward the NAV of the scheme will start to grow. But to make the NAV grow, the money needs to be invested properly in stocks, bonds etc. At the NFO stage, the mutual fund’s balance sheet will look like this:
When the collected funds is invested, say in stocks, the NAV will begin to grow in value. As the stock’s price grows, it will also take the NAV up with itself. If stock price will grow by say 1%, NAV will also go up by 1%.
The Solution
I’m sure, people who were not so interested to know about what is NAV and how it is calculated, I have probably bored them with the details (above). But I thought this article will be incomplete without narrating these two details by jumping straight to the solution.
Anyways, now we are here, and I’ll talk about the solution. What solution I was seeking? How to logically assign the gain and losses to the invested funds in my investment portfolio? This is symbolic of how to assign gains/losses to different investors buying mutual funds at different point in time. If you have already not read about my problem, please check it here.
I’ll again explain my solution using the same hypothetical example (as done above).
January – This is the start point of portfolio building. Rs.2,25,000 available for investment under one savings head. Before this amount gets invested and is used to buy stocks etc, I issue myself few units at a NAV of Rs.10 per share. Consider it like a NFO of a mutual fund. A symbolic representation of this is shown below.
February (2) – Right at the point where the NAV was Rs.10.0889, I decided to infuse Rs.50,000 more into my portfolio. In the process of doing this, I had to buy units of my portfolio at the current NAV of Rs.10.0889 per unit. This way I was able to purchase 4,955.4 nos units with Rs.50,000.
So you can see in the above infographic that, though Savings#2 has been included in the portfolio, but it is still not consuming on the gains generated by Savings#1. All this was possible because of the use of NAV/Units theory as followed by the mutual fund schemes.
Use of NAV was the ultimate solution to my problem.
Quick Look
Net Asset Value is calculated by summing current value of all assets minus the accumulated daily expenses of the mutual fund scheme.
In case of my personal portfolio, I also book my confirmed losses as expenses. The loss so booked is also adjusted in asset side of balance sheet by reducing the cash balance accordingly.
NAV is just a number. On its own it does not reflect the performance of a portfolio. But a historical NAV data can precisely highlight the performance of mutual fund. NAV of a mutual fund growing from Rs.10 to Rs.12 in a year, highlights a growth rate of 20% per annum.
(I have tried my level best to decode this NAV portion, see if find any valuable information this here)
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