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Why growth and dividend NAVs differ?
At Personalfn, we often get queries from investors on why
the difference between the NAVs (net asset values) of the growth and
dividend options does not have a logical relation. According to them, the
difference in the NAVs should co-relate to the dividend declared at a
point in time nothing more, nothing less. In this note, we simplify the
issue of the discrepancy in the growth and dividend NAVs
Growth vs. dividend
It’s important to first get an overview of the two options before we
venture into explaining why there is a discrepancy between them. Broadly,
mutual funds have two options - growth and dividend. Under the dividend
option, income generated by the mutual fund scheme on its investments is
distributed to the investor. This income/dividend is not assured by the
mutual fund and is linked closely to the performance of stock/debt
markets. The investor can choose to either encash the dividend or
re-invest it in the same mutual fund scheme (through the dividend
re-investment facility).
Under the growth option, the investor does not receive an
income; in this case the growth option NAV already reflects the growth in
investments (if any) registered by the mutual fund. If the investor is in
need of an income, he can redeem (either completely or partially depending
on his investment objective) his units; the difference in the growth
option between the time he bought the mutual fund and redeemed it is
effectively his income.
The common perception
Investors believe that after the dividend is distributed, growth NAV and
dividend NAV do not appreciate or depreciate in the same proportion. In
other words they believe that since the growth NAV is higher than the
dividend NAV, it has appreciated more than the dividend NAV. Therefore,
they think that they are better off selecting the growth option as opposed
to the dividend option. While there are several reasons why investors must
choose a particular option (growth or dividend), this is certainly not one
of them, mainly because the reality behind the discrepancy between the two
options is far from the perception. To know when to select which option,
read our article on this subject:
What happens when dividend is declared
Once a dividend is declared by the mutual fund, the dividend option NAV
diminishes to the extent of the dividend declared. The growth option NAV
on the other hand remains unchanged (for simplicity’s sake we have ignored
the market movement on that particular day). The diminution in the
dividend option NAV equals the amount of dividend declared.
A matter of dividend
| |
|
Growth |
Dividend |
| NAV as on January
1, 2007 |
Rs |
10.0 |
10.0 |
| NAV as on March
30, 2007 |
Rs |
12.0 |
12.0 |
| Dividend declared
as on March 31, 2007 |
% |
- |
10.0 |
| NAV as on March
31, 2007 |
Rs |
12.0 |
11.0 |
| NAV growth over
1-month |
% |
10.0 |
10.0 |
| NAV as on April
30, 2007 |
Rs |
13.2
|
12.1
|
| (We
have assumed that the growth and dividend options have similar
portfolios. If they have different portfolios then the discrepancy
will be due to a combination of market movements and their
respective portfolios. For simplicity’s sake we have ignored the
market movement on March 31, 2007) |
For instance, in our illustration (refer table) both
the growth and dividend NAVs have appreciated by 20% from the NFO (new
fund offer) period to close at Rs 12.0. The mutual fund declares 10.0%
dividend after which the dividend NAV declines to Rs 11.0 (ex-dividend).
The growth NAV on the other hand remains unchanged at Rs 12.0.
The difference between the growth and dividend NAVs
will equal the dividend declared (i.e. Re 1). However, the difference in
both the NAVs will equal the dividend declared only on the day of the
dividend declaration. The next day this difference will vary (from Re 1 in
this case) based on the market movement. For instance, lets assume that
markets appreciate by 10% over 1-month after the dividend declaration. In
that case, the growth option will rise from Rs 12.0 to Rs 13.2, while the
dividend option will rise from Rs 11.0 to Rs 12.1.
The 10% growth in NAV is based on the value of the
portfolio’s investments. Therefore, although the growth NAV seems higher
compared to the dividend NAV, both NAVs have appreciated proportionately.
The difference between the options is now Rs 1.1 while at the time of the
dividend declaration it was Rs 1.0.
What investors should do
As we have impressed no matter what option the investor chooses, dividend
and growth NAVs will appreciate/depreciate based on the market movement;
there is no other factor at play over here. Which option (growth or
dividend) to select is dictated entirely by the investor’s investment
objective and income/liquidity constraints.
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