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CHAPTER 8
TAXATION
CHAPTER 9
INVESTOR SERVICES
CHAPTER 10
RISK, RETURN AND PERFORMANCE OF FUNDS
CHAPTER 11
MUTUAL FUND SCHEME PERFORMANCE
CHAPTER 12 MUTUAL FUND SCHEME SELECTION
Appendix 1: Fifth Schedule of Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 [Regulations 18(22), 25(16), 68(h)]
Appendix 2: AMFI Code of Ethics
Appendix 3: AMFI’s Code of Conduct for Intermediaries of Mutual Funds
Appendix 4: Additional knowledge resources
CHAPTER 7
NET ASSET VALUE, TOTAL EXPENSE RATIO AND PRICING OF
LEARNING OBJECTIVES:
After studying this chapter, you should learn about:
Fair Valuation Principles and relevance for investors
Computation of Net Assets of mutual fund scheme
Dividends & Distributable Reserves
Concept of Entry and Exit Load and its impact on NAV
UNITS
Key accounting and reporting requirements applicable to mutual funds
NAV, Total expense ratio and pricing of units for the Segregated Portfolio
7.1 Fair Valuation Principles
An investor in a mutual fund scheme is the beneficial owner of the units one has bought. Expand this further, and it means that the ownership of the mutual fund scheme is collectively in the hands of all the investors at any point in time. At the same time, the investors can sell their units and new investors can buy. Thus, periodically, the ownership could also change. In such a case, it becomes very important that any investor in the scheme gets a fair price for one’s investments. In order to ensure such fair treatment to all investors, SEBI has laid down certain fair valuation principles.
The asset management companies are required to compute and carry out a valuation of investments made by its scheme(s) in accordance with the investment valuation
NET ASSET VALUE, TOTAL EXPENSE RATIO OF UNITS
norms specified in the Eighth Schedule of SEBI (Mutual Funds) Regulations, 1996. The primary objective behind the introduction of these principles was to ensure fair treatment to all investors including existing investors as well as investors seeking to purchase or redeem units of mutual funds in all schemes at all points of time. At the same time, the valuation principles also address the mispricing risk and reduce the vulnerability of short-term debt-oriented schemes to redemption pressure.
The 10 principles as laid out by SEBI are as under:
Principle No.1:
The valuation of investments shall be based on the principles of fair valuation i.e., valuation shall be reflective of the realizable value of the securities/assets. The valuation shall be done in good faith and in true and fair manner through appropriate valuation policies and procedures.
Principle No.2:
The policies and procedures approved by the Board of the Asset Management Company shall identify the methodologies that will be used for valuing each type of securities/assets held by the mutual fund schemes. Investment in new type of securities/assets by the mutual fund scheme shall be made only after establishment of the valuation methodologies for such securities with the approval of the Board of the asset management company.
Principle No.3:
The assets held by the mutual funds shall be consistently valued according to the policies and procedures. The policies and procedures shall describe the process to deal with exceptional events where market quotations are no longer reliable for a particular security.
Principle No.4:
The asset management company shall provide for the periodic review of the valuation policies and procedures to ensure the appropriateness and accuracy of the methodologies used and its effective implementation in valuing the securities/ assets. The Board of Trustee and the Board of asset management company shall be updated of these developments at appropriate intervals. The valuation policies
and procedures shall be regularly reviewed (at least once in a Financial Year) by an independent auditor to seek to ensure their continued appropriateness.
Principle No.5:
The valuation policies and procedures approved by the Board of asset management company should seek to address conflict of interest.
Principle No.6:
Disclosure of the valuation policy and procedures (with regard to valuation of each category of securities/assets where the scheme will invest, situation where these methods will be used, process and methodology and impact of implementation of these methods, if any) approved by the Board of the asset management company shall be made in Statement of Additional Information, on the website of the asset management company/mutual fund and at any other place where the Board may specify to ensure transparency of valuation norms to be adopted by asset management company.
Principle No.7:
The responsibility of true and fairness of valuation and correct NAV shall be of the asset management company, irrespective of disclosure of the approved valuation policies and procedures i.e., if the established policies and procedures of valuation do not result in fair/appropriate valuation, the asset management company shall deviate from the established policies and procedures in order to value the assets/ securities at fair value provided that: o any deviation from the disclosed valuation policy and procedures may be allowed with appropriate reporting to Board of Trustees and the Board of the asset management company and appropriate disclosures to investors.
Principle No.8:
The asset management company shall have policies and procedures to detect and prevent incorrect valuation.
Principle No.9:
Documentation of rationale for valuation including inter scheme transfers shall be maintained and preserved by the asset management company as per Regulation 50 of SEBI (Mutual Fund) Regulations, 1996 to enable audit trail.
Principle No.10:
In order to have fairness in the valuation of debt and money market securities, the asset management company shall take into consideration prices of trades of same security or similar security reported at all available public platform.
In addition to the above, a mutual fund may value its investments according to the Valuation Guidelines notified by SEBI. In case of any conflict between the Principles of Fair Valuation and Valuation Guidelines, the Principles of Fair Valuation detailed above shall prevail.
Valuation
A mutual fund scheme invests the investors’ money in a portfolio of securities created and managed based on the investment objective and strategy of the scheme. The investments include securities, money market instruments, privately placed debentures, securitised debt instruments, gold and gold related instruments, real estate assets and infrastructure debt instruments and assets. The NAV of the scheme will depend upon the value of this portfolio, which in turn, depends upon the value of the securities held in it. The valuation of these securities to determine the net asset value has to be done in accordance with the valuation guidelines laid down by SEBI and AMFI. This includes the following guidelines:
1. Traded Securities other than money market and debt securities:
a. The securities shall be valued at the last quoted closing price on the stock exchange.
b. When the securities are traded on more than one recognised stock exchange, the securities shall be valued at the last quoted closing price on the stock exchange where the security is principally traded. It would be left to the asset management company to select the appropriate stock exchange, but the reasons for the selection should be recorded in writing. There should, however, be no objection for all scrips being valued at the prices quoted on the stock exchange where a majority in value of the investments are principally traded.
c. Once a stock exchange has been selected for valuation of a particular security, reasons for the change of the exchange shall be recorded in writing by the asset management company.
d. When on a particular valuation day, security has not been traded on the selected stock exchange, the value at which it is traded on another stock exchange may be used.
e. When a security is not traded on any stock exchange on a particular valuation day, the value at which it was traded on the selected stock exchange or any other stock exchange, as the case may be, on the earliest previous day may be used provided such date is not more than thirty days prior to the valuation date.
Non-traded Securities’ other than money market and debt securities):
f. When a security is not traded on any stock exchange for a period of thirty days prior to the valuation date, the scrip must be treated as a ‘non-traded’ scrip.
g. Non-traded securities shall be valued “in-good faith” by the asset management company on the basis of appropriate valuation methods based on the principles approved by the Board of the asset management company. Such decision of the Board must be documented in the Board minutes and the supporting data in respect of each security so valued must be preserved. The methods used to arrive at values “in-good faith” shall be periodically reviewed by the trustees and reported upon by the auditors as “fair and reasonable” in their report on the annual accounts of the fund. For the purpose of valuation of non-traded securities61, the following principles should be adopted: —
i. equity instruments shall generally be valued on the basis of capitalization of earnings solely or in combination with the net asset value, using for the purposes of capitalization, the price or earnings ratios of comparable traded securities and with an appropriate discount for lower liquidity;
ii. in respect of convertible debentures and bonds, the non-convertible and convertible components shall be valued separately. The non-convertible component should be valued on the same basis
61 As per Clause ‘m’ of Ninth Schedule of SEBI (Mutual Fund) Regulations (1996), in the case of real estate mutual funds schemes, investments in unlisted equity shares shall be valued as per the norms specified by the Board in this regard.
NET ASSET VALUE, TOTAL EXPENSE RATIO OF UNITS
as would be applicable to a debt instrument. The convertible component should be valued on the same basis as would be applicable to an equity instrument. If, after conversion, the resultant equity instrument would be traded Pari passu with an existing instrument which is traded, the value of the latter instrument can be adopted after an appropriate discount of the non-tradability of the instrument during the period preceding the conversion while valuing such instruments, the fact whether the conversion is optional should also be factored in;
iii. in respect of warrants to subscribe for shares attached to instruments, the warrants can be valued at the value of the share which would be obtained on the exercise of the warrant as reduced by the amount which would be payable on exercise of the warrant. A discount similar to the discount to be determined in respect of convertible debentures [as referred to above] must be deducted to account for the period which must elapse before the warrant can be exercised;
2. Value of Gold: the gold held by a gold exchange traded fund scheme shall be valued at the AM fixing price of London Bullion Market Association (LBMA) in US dollars per troy ounce for gold having a fineness of 995.0 parts per thousand, subject to the conditions mentioned in valuation guidelines issued by SEBI in SEBI (MF Regulations), 1996.
3. Value of Silver: The silver held by a silver exchange traded fund scheme shall be valued at the AM fixing price of London Bullion Market Association (LBMA) in US dollars per troy ounce for silver having a fineness of 999.0 parts per thousand subject to the conditions mentioned in valuation guidelines issued by SEBI in SEBI (MF Regulations), 199662.
62 https://www.sebi.gov.in/legal/circulars/nov-2021/norms-for-silver-exchange-traded-funds-silver-etfs-and-goldexchange-traded-funds-gold-etfs-_54166.html and page no. 107: https://www.sebi.gov.in/legal/regulations/aug-2021/ securities-and-exchange-board-of-india-mutual-funds-regulations-1996-last-amended-on-november-09-2021-_41350. html
7.2 Computation of Net Assets of Mutual Fund Scheme and NAV
7.2-1 Net Assets of Scheme
Let us understand the concept with a simple example.
Investors have bought 20 crore units of a mutual fund scheme at Rs. 10 each. The scheme has thus mobilized 20 crore units X Rs. 10 per unit i.e., Rs. 200 crore.
An amount of Rs. 140 crores, invested in equities, has appreciated by 10 percent.
The balance amount of Rs. 60 crore, mobilized from investors, was placed in bank deposits and money market instruments.
Interest and dividend received by the scheme is Rs. 8 crore, scheme expenses paid is Rs. 4 crore, while a further expense of Rs. 1 crore is payable.
If the above details are to be captured in a listing of assets and liabilities of the scheme, it would read as follows:
Liabilities
Unit Capital (20 crore units of Rs. 10 each)200
Profits {Rs. 8 crore (interest and dividend received) minus Rs. 4 crore (expenses paid) minus Rs. 1 crore (expenses payable)} 3
Capital Appreciation on Investments held (10 percent of Rs. 140 crore)14
Unit-holders’ Funds in the Scheme217 Expenses payable1 Scheme Liabilities218
Assets
Market value of Investments (Rs. 140 crore + 10 percent)154
Bank Deposits and money market instruments {Rs. 60 crore (original) plus Rs. 8 crore (interest and dividend received) minus Rs. 4 crore (expenses paid)} 64
Scheme Assets218
NET ASSET VALUE, TOTAL EXPENSE RATIO OF UNITS
The unitholders’ funds in the scheme are commonly referred to as “net assets”. The assets of the scheme are the investments held by it. This along with the accrued income which includes dividend or interest due on securities held in the portfolio but not yet received, and receivables, such as the amount due on shares sold, constitute the total assets. The scheme may have some short-term liabilities and accrued expenses. The current liabilities include payables for securities bought and borrowings for a period not exceeding six months to meet liquidity needs.
As is evident from the table:
Net assets include the amount originally invested, the profits booked in the scheme, as well as the appreciation in the investment portfolio.
Net assets increase when the market prices of securities held in the portfolio increase, even if the investments have not been sold and profits realized.
A scheme cannot show better profits by delaying payments. While calculating profits, all the expenses that relate to a period need to be considered, irrespective of whether or not the expense has been paid. In accounting language, this is called the accrual principle.
Similarly, any income that relates to the period will boost profits, irrespective of whether or not it has been actually received in the bank account. This again is in line with the accrual principle.
7.2-2 Net Asset Value
In the market, when people talk of NAV, they refer to the value of each unit of the scheme.
This is equivalent to:
Unit-holders’ Funds in the Scheme (Net Assets) ÷ No. of outstanding Units
In the above example, it can be calculated as:
Rs. 217 crore ÷ 20 crore
i.e., Rs. 10.85 per unit.
An alternate formula for calculating NAV is:
(Total Assets minus Liabilities other than to Unitholders) ÷ No. of outstanding Units
NET ASSET VALUE, TOTAL EXPENSE RATIO OF UNITS
i.e., (Rs. 218 crore – Rs. 1 crore) ÷ 20 crore
i.e., Rs. 10.85 per unit.
From the above, it follows that:
a. Higher the interest, dividend and capital gains earned by the scheme, higher would be the NAV.
b. Higher the appreciation in the investment portfolio, higher would be the NAV.
c. Lower the expenses, higher would be the NAV.
The summation of these three parameters gave us the profitability metric as being equal to:
(A) + Interest income
(B) + Dividend income
(C) + Realized capital gains
(D) + Valuation gains
(E) – Realized capital losses
(F) – Valuation losses
(G) – Scheme expenses
Example 1: Calculate the NAV given the following information:
Value of stocks: Rs. 150 crores
Value of bonds: Rs. 67 crores
Value of money market instruments: Rs. 2.36 crore
Dividend accrued but not received: Rs. 1.09 crore
Interest accrued but not received: Rs. 2.68 crore
Fees payable: Rs. 0.36 crore
No. of outstanding units: 1.90 crore
NAV = (Value of stocks + Value of bonds + Value of money market instruments + Dividend accrued but not received + Interest accrued but not received – Fees payable)/No. of outstanding units
The Mutual Fund Distributor workbook offers a concise yet thorough understanding of mutual fund concepts, regulatory frameworks, and best distribution practices. It aims to empower readers with critical knowledge, seamlessly blending foundational investment principles and the latest Indian regulatory guidelines. This book is intended for the following audience:
• Aspiring Mutual Fund Distributors
• Employees of AMCs and Distribution Houses
• Financial Advisors and Planners
• Students and Researchers
The Present Publication is the December 2024 Workbook Version, developed in collaboration with the Certification Team of NISM and Mr Sundar Sankaran, Ms Sunita Abraham, Mr Amit Trivedi, and Mr Joydeep Sen. It is published exclusively by Taxmann, with the following noteworthy features:
• [Aligned to NISM Certification Requirements] Meets the SEBI-mandated knowledge benchmarks for mutual fund distributors
• [Comprehensive Coverage] Spans basic to advanced topics: types of mutual funds, distribution mechanisms, risk-return metrics, and legal-regulatory frameworks
• [Lucid & Focused Content] Presents concepts clearly, supplemented by realworld examples and illustrative case studies
• [Industry-endorsed & Reviewed] Refined in consultation with seasoned industry professionals and resource persons
• [Practical Insights] Offers guidance on investor services, KYC processes, taxation, and everyday distribution practices
