Navigating the NAV

Understanding net asset value can be key to understanding how different fund types work.

Adam Zoll 2 March, 2015 | 6:00PM

Question: When I check the Quote pages for all my mutual funds on Morningstar.ca the unit price is expressed as "NAV." Why is this?

Answer: Every mutual fund Quote page on Morningstar.ca begins with a quoted net asset value, NAV, for the fund. At the most basic level, net asset value is the current price for one unit of a fund. Net asset value, as the name suggests, reflects the value of the fund's net assets (assets minus liabilities, such as the cost to operate the fund) divided by the number of units. Next to the fund's closing price (NAV) you'll find the amount and percentage by which its NAV changed relative to the previous trading day.

NAV can be a confusing concept for some investors because it's less straightforward than stock price, which is determined by the market, can be tracked throughout the day, and is easily understood to represent the price of one share of a company's stock. A mutual fund, on the other hand, is a basket of stocks (and/or bonds and cash) that doesn't trade on a market and which has its unit price determined by the fund company after the market closes. To calculate a fund's NAV, the fund company totals up the value of all the securities in the fund's portfolio, keeping a small slice of the total assets for itself as payment for running the fund. What's left over is the fund's net asset amount, which is then divided by the number of units outstanding to provide fund investors with an idea of how much each unit is worth.

NAV and distributions

The main driver of changes in a fund's NAV is the performance of its underlying securities, but capital gains and dividends produced by the fund also are a factor. Confusion over mutual fund NAV tends to occur around the time a fund distributes its capital gains or dividends because there is typically an accompanying drop in NAV. As explained in this previous Ask the Expert article, when a mutual fund pays distributions, such as capital gains from the sale of underlying securities or dividends from its holdings, that payout to unitholders reduces the fund's NAV by a like amount. For example, let's say a fund with an NAV of $10 per unit pays out gains and dividends equal to $1 per unit. Its NAV then becomes $9 per unit, with the remaining $1 now in unitholders' hands. Distributions may be taken in the form of cash payments or additional units in the fund if the unitholder so chooses. The underlying securities in the fund are unaffected by the transaction.

NAV also can be a source of confusion when dealing with other fund types, such as exchange-traded funds and closed-end funds. Here NAV plays a slightly different role because of the nature of these investment vehicles and how they are traded.

NAV and ETFs

Let's start with ETFs. As we said earlier, a traditional, open-ended mutual fund is not traded on the market, but rather its NAV is calculated after the market closes. An ETF, on the other hand, is traded on the market, which is a key distinction. ETFs, like traditional mutual funds, are baskets of securities, but because they are traded throughout the day, their NAVs also change throughout the day. In addition, with ETFs there's the potential to pay more or less for an ETF than the value of the securities in the portfolio. This can happen, for instance, when demand for shares of an ETF boosts its price even though its underlying securities haven't appreciated at the same rate. While not significant in most liquid, equity-based ETFs, premiums and discounts are more common in ETFs that deal with less liquid securities, such as bonds or international stocks. (For a fuller discussion of why this happens, see this article by Morningstar ETF analyst Michael Rawson.)

One reason that wide gaps between an ETF's market price and its NAV are not more common is that authorized participants--which is a fancy name for the institutions overseeing the operation of the ETF--can create new shares or redeem old ones if things get too far out of whack, thus helping to bring the share price closer in line with the NAV.

Because ETFs' NAVs are more complicated than is the case with traditional mutual funds, Morningstar provides additional data. On the top left of Morningstar.ca's ETF Quote pages, you'll find the ETF's last trade price along with that day's overall price and percentage changes. To the right you'll see the ETF's official NAV per share as of the previous market close. Click on the Performance tab, and you'll find that the ETF's return is expressed both in terms of its price and its NAV. The former provides a look at what ETF investors actually experienced in holding the ETF while the latter provides a sense of how its underlying securities performed. For example, in the 2014 calendar year,  iShares Core S&P/TSX Capped Composite XIC returned 10.95% on a price basis whereas it returned 10.42% on an NAV basis. To see how closely an ETF tends to track its NAV, go to the Quarterly & Monthly Total Returns section under the Performance tab. There you'll find monthly and quarterly return data both on a price and an NAV basis.

NAV and CEFs

Another investment vehicle in which NAV comes into play, this time in a more significant way, is closed-end funds. Like traditional mutual funds and ETFs, they hold baskets of securities, and like ETFs, shares are bought and sold throughout the trading day. But unlike traditional mutual funds and ETFs, which are considered open-ended in that they add or subtract assets based on customers' desire to invest in the fund, CEFs are essentially fixed asset pools of investments that rise or fall in value based on demand for their underlying securities and the distributions they give off. This closed structure can lead to share prices that are at significant discounts or premiums to the fund's net asset value. This might happen because of factors such as the CEF's distribution rate, market volatility, a gap in demand for the CEF and for its underlying securities, and even the reputation of the fund's manager.

NAV is an easy metric for the casual investor to overlook. But understanding what it represents is essential, especially when investing in ETFs and CEFs, where the spread between share price and the value of underlying holdings can affect returns.

Have a personal finance question you'd like answered? Send it to AskTheExpert@morningstar.com.

About Author

Adam Zoll

Adam Zoll  Adam Zoll is an assistant site editor with Morningstar.com