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Navigating the NAV

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

Adam Zoll 3 October, 2012 | 6:00AM

Question: When I check the quote pages for funds on Morningstar.co.uk the share prices are expressed as "NAV." Why is this?

Answer: Every quote page for open-end funds on Morningstar.co.uk has 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 shares. Below the fund's closing price (NAV), you'll find the 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. An open-end 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 share 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 shares outstanding to provide fund investors with an idea of how much each share is worth.

NAV and Distributions

The main driver of changes in a fund's NAV is the performance of its underlying securities, but dividends produced by the fund also are a factor. Confusion over fund NAV tends to occur around the time a fund distributes its dividends because there is typically an accompanying drop in NAV.

When a fund pays out dividends from its holdings, that payout to shareholders reduces the fund's NAV by a like amount. For example, let's say a fund with a NAV of £10 per share pays out dividends equal to £1 per share. Its NAV then becomes £9 per share, with the remaining £1 now in shareholders' hands. Distributions may be taken in the form of cash payments or additional shares in the fund if the shareholder so chooses. The underlying securities in the fund are unaffected by the transaction.

NAV can also be a source of confusion when dealing with other fund types, such as exchange-traded funds (ETFs) and closed-end funds (aka investment trusts). 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 explained earlier, a traditional, open-ended 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 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 this is 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.

One reason wide gaps between an ETF's market price and its NAV are not more common is that authorised 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.

NAV and Investment Trusts

Another investment vehicle where NAV comes into play, this time in a more significant way, is closed-end funds, which are also called investment trusts.

With traditional open-end funds, you can be assured that the price you pay or receive when you buy into a fund is directly linked to the fund’s NAV. Closed-end funds operate differently. 

Like traditional funds and ETFs, they hold baskets of securities, and like ETFs, shares are bought and sold throughout the trading day. But unlike traditional funds and ETFs, investment trusts are essentially fixed asset pools of investments with a fixed number of shares. The price for those limited number of shares rise and fall in value based on investment demand. If demand for an investment trust is high, shares may trade at a premium to their NAV. If demand for an investment trust is low, shares may trade at a discount to their NAV. Many investment trusts trade at discounts to the value of their underlying assets.

On Morningstar.co.uk's investment trust quote pages you'll find not only updated share price information, but also NAV and current and historical average discount data.

For more information about investment trusts, read: "What is an Investment Trust?" and "Investment Trust Quirks and How To Manage Them".

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

The original version of this article was published October 2012 on Morningstar.com, a sister site to Morningstar.co.uk.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Adam Zoll  is an assistant site editor with Morningstar.com, the sister site of Morningstar.co.uk.