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EmailBut before you can take advantage of what NAV is telling you about a fund, you need to understand what NAV is.
The Ins and Outs of Net Asset Value
Put simply, net asset value measures the value of a fund's assets, minus its liabilities. The formula for calculating NAV is:
NAV per share = (Market value of all securities held by fund + Cash and equivalent holdings - Fund liabilities) / Total fund shares outstanding
So if a particular fund held $8,500,000 worth of securities, $2,000,000 of cash, $500,000 of liabilities and had 1,000,000 shares outstanding, then the fund's NAV per share would be:
NAV = ($8,500,000 + $2,000,000 - $500,000) / 1,000,000 = $10.00
The NAV changes daily as the value of a fund's securities, cash held, liabilities, and the number of shares outstanding fluctuates.
Making NAV Work for You
Traditional open-end mutual funds and their closed-end cousins share many common traits, but also a few key differences. For example, CEFs are more liquid, can use leverage
Of course, the most striking difference is that open-end mutual funds trade precisely at their net asset value (NAV). By contrast, CEFs can -- and often do -- trade above (premium) or below (discount) the value of their underlying assets.
While there will be situations in which it is acceptable to buy funds changing hands at a premium, it is generally more advantageous to look for those that are currently on sale. After all, if the net value for our fictional fund above ends up at $10 per share, yet its current market price is just $9, then investors are being handed the rare opportunity to scoop up $1 worth of assets for just 90 cents.
When Mr. Market tosses a stock in the bargain bin, it's often because the company has suffered deteriorating operating performance or is facing some other obstacle. However, this isn't necessarily the case with closed-end funds -- many funds with rock-bottom price tags happen to be top-tier performers.
Because CEFs trade on the open market, they are subject to the whims of supply and demand. As such, there is typically a discrepancy between price and value -- sometimes a wide one.
There is no single reason to explain why a fund might trade below its NAV, but academic studies have isolated several contributing factors, most notably: relative performance, embedded unrealized capital gains, investor sentiment, scarcity of competing funds, the name-brand recognition of the manager or fund company, and the existence of a managed distribution policy. Regardless of the cause, if you can swoop in on a discounted fund at the right time, you can reap huge rewards.
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