NAV (Net Asset Value) refers to the total equity of a business. While NAV can be applied to any entity, it is mostly used to reference investment funds, such as mutual funds and ETFs.
Here is how to calculate NAV:
NAV = Fund Assets – Fund Liabilities
Importance of NAV
Whether using it for a business or a fund, the NAV is an important metric that reflects the total shareholder (or unitholder) equity position. By dividing the NAV by the number of shares or units outstanding, one can determine the net asset value per share (NAVPS). The higher the NAV or NAVPS, the higher the value of the fund or the company.
Implications for Investment Funds
1. Fund accounting
The NAV calculation is one of the many activities conducted by fund accounting, which is a middle-office function of an investment management firm. Due to the complexities of an investment fund, the fund accounting process involves layers of computer systems that help with the calculations of net asset value. The systems help track the following information:
Investment capital inflows and outflows
Purchases and sales of investments
Investment income, gains, and losses
Depending on the type of fund, fund accounting will use the information above to recalculate the NAV on a daily, weekly, monthly, or even quarterly basis.
2. Open-end funds
The NAVPS is especially critical for open-end funds, i.e., mutual funds, as it is the reference point for determining the share or unit price of a fund. A fund will issue and redeem shares by pricing them proportionally based on the NAV of the fund.
As an example, say a fund reports a NAV of $10 million and one million shares outstanding. The NAVPS would be $10, so an investor purchasing $1 million worth of shares would own 100,000 shares. The investment will subsequently increase the net asset value of the fund by $1 million for a total NAV of $11 million.
3. Closed-end funds
Unlike the example above of an open-end fund, closed-end funds only issue a finite number of shares. Since the shares trade on the open market, the share prices are less dependent on the NAVPS than those in open-end funds. Closed-end funds that trade on public exchanges are often priced at a discount to the fund’s net asset value.
Other Uses of NAV
1. Investing in public companies
Value investors can evaluate potential investments in public companies by comparing the net asset value of the company with its market capitalization or the market valuation price for the entire company. Unlike an investment fund, the NAV calculation for a company will value assets using book value, amortized, or historical costs (or a combination of each).
A company’s stock can be considered “cheap” when its market capitalization is higher than its NAV, making it a potential candidate for a value investor.
2. Real Estate Investment Trusts (REITs)
Real estate investment trusts (REITs) also use net asset value as a key valuation metric. In the case of a REIT, the NAV is often quoted on a per unit basis that reflects the market prices of the real estate investments held by the trust. The NAV is similar to the price-to-book ratio since unrealized gains and losses of each property will be reflected.
3. Insurance contracts
Some life insurance policies and annuities (such as segregated funds) can act like mutual funds. Insurance policies also require NAV calculations since their asset values can fluctuate. Like mutual funds, the insurance contracts issue units to policyholders in exchange for their investment and base the reference price on the net asset value of the underlying portfolio.
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