Fair Valuation Principles :
- Investor Ownership: Mutual fund units represent investor ownership; as investors enter and exit, fair valuation ensures equitable treatment.
- SEBI Regulations: Valuation must follow SEBI’s Eighth Schedule norms to prevent mispricing and safeguard all investors, including during redemptions.
- Principles of Fair Valuation:
- Principle 1: Valuation should reflect realizable value, done in good faith.
- Principle 2: AMC Board must pre-approve valuation methods for each asset type.
- Principle 3: Consistency in valuation, with procedures for exceptional events.
- Principle 4: Policies must be reviewed annually by an independent auditor.
- Principle 5: Procedures should address conflicts of interest.
- Principle 6: Valuation policies must be disclosed to ensure transparency.
- Principle 7: AMCs are responsible for fair NAVs and may deviate from policy if needed, with proper reporting.
- Principle 8: AMCs must prevent incorrect valuation.
- Principle 9: Rationale for valuations must be documented for audit trail.
- Principle 10: Debt/money market securities should consider trade prices from all public platforms.
- Valuation Guidelines:
- Traded Securities: Valued at last quoted price on principal stock exchange.
- Non-Traded Securities: Valued in good faith using board-approved methods, such as earnings capitalization or NAV with discounts.
- Convertible Instruments & Warrants: Valued separately using equity/debt principles, with discounts for liquidity and optionality.
- Gold & Silver ETFs: Valued at LBMA AM fixing price in USD based on purity standards and SEBI regulations.
- Learning Objectives: Understand valuation principles, NAV computation, loads, expense ratios, and reporting norms for mutual funds.
Computation Of Net Assets Of Mutual Fund Scheme & NAV :
- Net Assets of Mutual Fund Scheme:
- Net assets = Assets – Liabilities; include original investment, booked profits, and market appreciation.
- All expenses and income are recorded as per the accrual principle (recognized when incurred/earned, not when paid/received).
- NAV (Net Asset Value):
- NAV = Net Assets ÷ No. of Outstanding Units.
- NAV increases with higher income and capital gains; decreases with higher expenses.
- Accurate NAV calculation ensures fair unit pricing and reflects scheme performance.
- Mark to Market:
- Valuing investments at current market prices ensures NAV reflects real portfolio worth.
- Issuing/redemption at face value rather than NAV can unfairly dilute or enhance value for investors.
- Total Expenses in Mutual Fund Scheme:
- Include advisory fees, marketing, audit, brokerage, custodian, statutory costs, etc.
- TER (Total Expense Ratio) caps are based on scheme type and AUM slabs.
- Additional 0.30% TER allowed for inflows from beyond top 30 cities, subject to conditions.
- Valuation of Perpetual Bonds (AT1/AT2):
- Investment cap: max 10% of scheme’s assets in such bonds; 5% per issuer.
- Deemed maturity set by SEBI for valuation: 10–20 years based on bond type and date.
Dividends & Distributable Reserves :
- Valuation Basis: Investments are valued at market price to reflect true NAV; income and expenses are accrued regardless of actual receipt/payment.
- Realization Principle: Valuation gains are not considered real until investments are sold; thus, they are excluded from distributable reserves.
- Distributable Reserves Calculation:
- Includes accrued income and expenses.
- Excludes valuation gains; includes valuation losses.
- Sale price attributed to valuation gains in new units is excluded.
- Dividend Declaration:
- Trustees decide dividend and record date.
- For frequent dividends, AMC officials may declare it (subject to trustee ratification).
- NAV is adjusted on record date; dividend details must be communicated publicly within a day.
- Notice Requirements:
- Five-day notice before record date (except for certain debt/liquid schemes).
- Listed schemes must follow listing agreement guidelines.
- No Dividend Guarantee: Dividends are not assured in terms of rate or regularity.
- Equalisation Reserve: Realised gains contribute to reserves used for dividends; investors must be informed if dividend includes capital distribution.
Concept Of Entry Load & Exit Load And Its Impact On NAV :
- Open-ended schemes allow continuous buying (sale) and selling (re-purchase) of units.
- Entry load (previously allowed) was the difference between Sale Price and NAV; now banned by SEBI, so Sale Price = NAV.
- Exit load is still permitted and is the difference between NAV and re-purchase price (e.g., 1% exit load on NAV of Rs. 11 gives Rs. 10.89 re-purchase price).
- Exit loads can reduce over time to encourage long-term holding (e.g., 4% in year 1, 3% in year 2).
- SEBI mandates uniform exit loads across all investors and no exit load on bonus or dividend reinvestment units.
- Exit loads must be credited to the scheme, not used for AMC expenses.
- Transaction charges do not affect NAV but increase the investor’s cost.
Key Accounting And Reporting Requirements :
- Scheme accounts must be separate from AMC accounts, with different auditors for each.
- Accounting norms are set for recording interest, dividends, and other entitlements.
- NAV must be calculated to 4 decimals for index, liquid, and debt funds.
- NAV for equity and balanced funds requires at least 2 decimal places.
- Investors may hold fractional units, though exchanges may allow trading only in whole units.
- NAV, portfolio, and scheme disclosures must follow prescribed frequencies.
NAV, Total Expense Ratio & Pricing Of Units For The Segregated Portfolio :
- SEBI allows segregated portfolios in mutual fund schemes to handle credit events and liquidity risks.
- No investment or advisory fees are allowed on segregated portfolios.
- TER (excluding investment/advisory fees) can be charged only on recovered amounts, on a pro-rata basis.
- NAV of segregated portfolios must be declared daily.
- Full disclosures about segregated portfolios are required in all scheme documents and reports.