Dividend Season Nearing, Highly Undervalued Prices: Here's Why Things Look Promising on Mutual Funds

There are a total of 18 close-ended mutual funds in Nepal. Close-ended mutual funds have a fixed amount of funds and have a predetermined maturity period. Furthermore, the units of close-ended mutual funds can be traded in NEPSE.

What you should know about mutual funds

All mutual funds are issued at a par value of Rs. 10 per share. A mutual fund is a professionally managed pool of money collected from investors to invest in securities. Securities mean investment assets like stocks, bonds, money market instruments, etc. Thus, after the collection of the fund, the fund managers invest in stocks, debentures, IPOs, and fixed deposits.

Based on the performance of their investment, the NAV of the funds is determined. According to Investopedia,

Net asset value (NAV) represents a fund's per share market value. It is the price at which investors buy ("bid price") fund shares from a fund company and sell them ("redemption price") to a fund company. It is derived by dividing the total value of all the cash and securities in a fund's portfolio, less any liabilities, by the number of shares outstanding.

Moreover, there is another measure of a mutual fund's performance: its LTP. Investors closely observe the investment areas of the funds and the profitability. They then determine the market price of the fund via a free-market mechanism of supply and demand.

How an investor can take advantage of the difference in NAV and LTP

The NAV and the market price (LTP) are rarely equal. While the company's actual performance until now is reflected in the NAV, the LTP incorporates investor sentiment, future expectation, and the general market trend.

In this article, we compare the NAV and LTP of the mutual funds that are currently traded in NEPSE. A lower LTP than the NAV means that investors are undervaluing the mutual fund. Meanwhile, if the LTP is higher than the NAV, it means that investors are optimistic about the mutual fund and they have overvalued it.

If one believes in the strategy of buying undervalued securities and selling when they are overvalued, perhaps the comparison of a mutual fund's NAV and LTP might lead him to something useful.

Note that investors can be right as much as they can be wrong. Although we compare the NAV and LTP in a straightforward way, nothing presented in this research should be taken as a buy or sell suggestion.

Only close-ended funds are traded in NEPSE. Open-ended funds do not have an LTP. Thus, we are only concerned about close-ended mutual funds in this article.

How to read and understand the comparison table shown below

1) The latest NAV of mutual funds is listed. These are mostly the latest NAV unveiled last week.

2) The LTP is the closing price of the mutual funds on the last trading day.

3) Premium means that the mutual fund is trading at a higher price than its NAV. Meanwhile, a Discount means that it is trading at a lower price.

*Weekly NAV is of April 9

Key Takeaways

1) All the mutual funds are trading at a lower price than their respective NAV, as shown by the table.

“The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions.”

— Seth Klarman

Is the pessimism towards mutual funds an overreaction from the investors? Data illustrates that the funds are extremely undervalued if we only consider the NAV and the price at which the funds are being traded in the secondary market. Furthermore, the LTP for most mutual funds is at a discount higher than 25% from the NAV, which looks like a significant undervaluation. 

2) Mutual funds are currently the best investment option for beginners.

Mutual funds are comparatively safer investment vehicles. They may prove highly profitable for beginners who want to reap the benefits of the stock market without putting in the required effort while investing themselves. Furthermore, mutual funds are great entry options for beginners to test the water while they are learning a strategy of their own.

Although mutual funds are not 100% safe, they certainly hedge the inevitable risks in the securities market. Mutual funds are required to diversify their portfolio by law. Since a significant volume of new investors has entered the stock market in the recent IPO boom and NEPSE's bullish rise, mutual funds may be of interest to them.

3) We are nearing the dividend distribution season for mutual funds.

Mutual funds begin to distribute their yearly dividends in the month of Shrawan (Just after completion of running fiscal year). For risk-averse investors who want a consistent return, investing in mutual funds might give them a first-mover advantage. This is because the funds are distributing their dividends shortly, and one might profit from the percentage returns via the dividend even if they do not from price appreciation.