VII. NET ASSET VALUE, TOTAL EXPENSE RATIO AND PRICING OF UNITS

Table of Contents

NET ASSET VALUE, TOTAL EXPENSE RATIO, AND PRICING OF UNITS

Net Asset Value (NAV):

  • NAV represents the per-unit value of a mutual fund scheme.
  • It is calculated by dividing the total value of the scheme’s assets minus liabilities by the number of units outstanding.
  • NAV is usually calculated at the end of each business day.

Total Expense Ratio (TER):

  • TER represents the total expenses incurred by a mutual fund scheme as a percentage of its average net assets.
  • It includes management fees, administrative costs, distribution expenses, etc.
  • Lower TER indicates a more cost-effective scheme.

Pricing of Units:

  • The price of units in a mutual fund scheme is determined based on the NAV.
  • Investors can buy or sell units at the prevailing NAV.
  • The purchase price is usually higher than the NAV due to additional charges like entry load, if applicable.

Fair Valuation Principles:

  • SEBI has established fair valuation principles to ensure fair treatment to all mutual fund investors.
  • Valuation of investments should be reflective of their realizable value and done in good faith.
  • Policies and procedures should be established for valuing different types of securities/assets.
  • Consistent valuation should be followed, with provisions for exceptional events where market quotations are unreliable.
  • Periodic review and independent audit of valuation policies and procedures are necessary.
  • Conflicts of interest should be addressed, and transparency in valuation norms should be ensured.
  • Asset management companies have the responsibility to value assets at fair value, even if it deviates from the disclosed policies and procedures.
Principle No.Summary
1Valuation based on fair value principles, in good faith and in a true and fair manner.
2Approved methodologies for valuing each type of securities/assets, with the Board’s approval.
3Consistent valuation of assets, with provisions for exceptional events where market quotations are unreliable.
4Periodic review and independent audit of valuation policies and procedures.
5Addressing conflict of interest in valuation policies and procedures.
6Disclosure of valuation policies and procedures for transparency.
7Responsibility of asset management company for fair valuation, with appropriate reporting and disclosures.
8Policies and procedures to detect and prevent incorrect valuation.
9Documentation and preservation of rationale for valuation.
10Consideration of prices of trades of same or similar securities in valuation of debt and money market securities.

NET ASSET VALUE, TOTAL EXPENSE RATIO, AND PRICING OF UNITS

Fair Valuation Principles:

  1. Valuation of investments should reflect the realizable value of the securities/assets and be done in good faith and in a true and fair manner.
  2. Asset management companies (AMCs) should establish valuation methodologies for each type of security/asset held by mutual fund schemes.
  3. Consistent valuation of assets should be maintained, with procedures to address exceptional events where market quotations are unreliable.
  4. Periodic review of valuation policies and procedures should be conducted to ensure their appropriateness and accuracy.
  5. Valuation policies and procedures should address conflicts of interest.
  6. Transparency should be maintained through disclosure of valuation policies and procedures in the Statement of Additional Information and other specified locations.
  7. The responsibility for fair valuation and correct Net Asset Value (NAV) lies with the AMC, and any deviation from established policies should be reported to the Board of Trustees and the AMC’s Board.
  8. Policies and procedures should be in place to detect and prevent incorrect valuation.
  9. Documentation of rationale for valuation, including inter-scheme transfers, should be maintained.
  10. Fairness in the valuation of debt and money market securities should consider prices of trades of the same or similar securities reported at public platforms.

Valuation:

  1. The Net Asset Value (NAV) of a mutual fund scheme depends on the value of its portfolio, including securities, money market instruments, gold, real estate assets, etc.
  2. Traded securities are valued at the last quoted closing price on the principal stock exchange or the stock exchange where they are primarily traded.
  3. Non-traded securities are valued “in good faith” based on approved valuation methods, considering factors like earnings, net asset value, and liquidity.
  4. Gold and silver held by exchange-traded fund schemes are valued at the AM fixing price of London Bullion Market Association (LBMA) per troy ounce.
  5. NAV can be calculated as Net Assets divided by the number of outstanding units.
  6. Mark-to-market valuation is used to reflect the true worth of each unit based on the current market value of securities, ensuring fair prices for investors.

Total Expenses in Mutual Fund Scheme:

  1. Mutual funds incur various expenses, including investment and advisory fees, marketing expenses, brokerage, audit fees, registrar services, etc.
  2. Recurring expenses are charged to the scheme, and the total expense ratio (TER) sets limits on the expenses based on the type of scheme.
  3. TER limits differ for different types of schemes, including equity-oriented, index fund, exchange-traded fund, and close-ended schemes.
  4. Brokerage and transaction costs are allowed up to a certain percentage of the trade value.
  5. Additional expenses may be charged for inflows from beyond the top 30 cities, subject to certain conditions.
  6. Excess expenditure beyond the prescribed TER limit should be borne by the AMC.
  7. TER and scheme-wise expenses must be prominently disclosed on the AMC’s and AMFI’s websites.

Valuation of Perpetual Bonds:

  1. Mutual funds have limits on investing in perpetual bonds issued by a single issuer and overall exposure to such instruments.
  2. Valuation of perpetual bonds is determined based on their deemed residual maturity, which changes over time.
  3. Close-ended debt schemes cannot invest in perpetual bonds due to maturity constraints.
  4. There is a phased movement towards valuing perpetual bonds with a 100-year maturity date.
  5. Macaulay Duration is calculated based on the deemed residual maturity, and if the call option is not exercised, valuation considers 100 years from the date of issuance or contractual maturity.
  6. Financial stress or bad news related to the issuer should be reflected in the valuation.

DIVIDENDS & DISTRIBUTABLE RESERVES

  1. Valuation gains in the mutual fund scheme’s portfolio are not realized until the investments are sold.
  2. Dividends can be paid out of distributable reserves, which consist of realized profits available for distribution.
  3. Accrued income and expenses are considered in calculating distributable reserves, but valuation gains are ignored.
  4. Valuation losses need to be adjusted against the profits before determining the distributable reserves.
  5. Dividend quantum and record date are decided by the trustees, with possible delegation to AMC officials for dividends up to monthly frequency.
  6. The record date is used to determine the eligibility of investors to receive dividends based on the register of unitholders.
  7. The NAV is adjusted at the end of the record date to reflect the dividend payout.
  8. The AMC is required to issue a public communication within one day of the trustees’ decision, providing details of the dividend and the record date.
  9. Failure to pay dividends by the stipulated time may result in interest being calculated on the delayed payment from the record date.
  10. Notice requirements for dividend distribution may vary based on the scheme type, with specific disclosures in the Scheme Information Document (SID).
  11. Listed schemes must follow the requirements stipulated in the listing agreement for declaring and distributing dividends.
  12. There is no guarantee or assurance to unitholders regarding the rate or quantum of dividend distribution.
  13. Dividends may include a certain portion of the investors’ capital, as a proportion of the sale price of investments represents realized gains credited to an equalization reserve.
  14. Mutual funds should clearly indicate the distinction between the appreciation of NAV and capital distribution in the dividend paid to investors.

CONCEPT OF ENTRY AND EXIT LOAD AND ITS IMPACT ON NAV

  1. Open-ended schemes allow investors to acquire new units (sale transaction) or sell units back to the scheme (re-purchase transaction).
  2. Entry load, which was previously charged as a difference between the Sale Price and NAV, is no longer permitted. Sale Price is now the same as the NAV.
  3. Exit load is the difference between the NAV and re-purchase Price. It can be calibrated based on the holding period, incentivizing investors to hold units longer.
  4. SEBI has banned entry loads, making the Sale Price equal to the NAV, subject to applicable transaction charges.
  5. No distinction is made among unitholders for exit loads based on the amount of subscription. Any imposition or enhancement of the load applies only to prospective investments.
  6. Exit loads are credited back to the scheme immediately and cannot be used by the AMC for selling expenses.
  7. Bonus units and units allotted on reinvestment of dividends are exempt from exit loads.
  8. Transaction charges do not affect the NAV per unit or the purchase price. They only impact the cost for the investor.

Example: If an investor invests Rs. 25,000 in a scheme with a NAV of Rs. 43.21, they will receive 578.570 units (Rs. 25,000 / Rs. 43.21). Transaction charges do not affect the unit price but impact the overall cost for the investor.

KEY ACCOUNTING AND REPORTING REQUIREMENTS

  1. The accounts of mutual fund schemes must be maintained separately from the accounts of the Asset Management Company (AMC). The auditor for the AMC and the schemes should be different.
  2. Specific norms are prescribed for reflecting interest, dividends, bonus issues, rights issues, and other events in the scheme’s accounts.
  3. Net Asset Value (NAV) calculation:
    • For index funds, liquid funds, and other debt funds, NAV is calculated up to 4 decimal places.
    • For equity and balanced funds, NAV is calculated up to at least 2 decimal places.
    • Investors can hold units even in fractional amounts, but some stock exchange trading systems may restrict trading to whole units.
  4. Frequency of disclosures:
    • NAV, portfolio details, and scheme accounts should be disclosed at specified intervals, as discussed earlier.

These accounting and reporting requirements ensure transparency, accuracy, and adherence to regulatory guidelines in the operations of mutual fund schemes. By maintaining separate accounts, following precise calculations of NAV, and providing timely disclosures, investors can make informed decisions and have confidence in the integrity of the mutual fund industry.

NAV, TOTAL EXPENSE RATIO, AND PRICING OF UNITS FOR THE SEGREGATED PORTFOLIO

To ensure fair treatment to all investors in case of a credit event and to address liquidity risks, mutual fund schemes are allowed to create segregated portfolios consisting of debt and money market instruments. The following key provisions apply to the NAV, Total Expense Ratio (TER), and pricing of units for the segregated portfolio:

  1. Investment and Advisory Fees: The Asset Management Company (AMC) cannot charge investment and advisory fees on the segregated portfolio. However, TER (excluding investment and advisory fees) can be charged on a pro-rata basis only after recovering the investments in the segregated portfolio.
  2. Daily NAV Declaration: The NAV of the segregated portfolio should be declared on a daily basis. This ensures transparency and provides investors with up-to-date information on the value of their investments.
  3. Disclosure Requirements: Adequate disclosure of the segregated portfolio must be included in all scheme-related documents, including monthly and half-yearly portfolio disclosures, as well as the annual report of the mutual fund and the scheme. These disclosures help investors understand the composition and performance of the segregated portfolio.

The segregation of the portfolio allows for the appropriate management of credit events and liquidity risks, ensuring that the interests of all investors are protected. By exempting investment and advisory fees on the segregated portfolio and providing transparent disclosures, mutual funds maintain transparency and fairness in their operations.