Net Asset Value, Total Expense Ratio and Pricing of units

Net Asset Value, Total Expense Ratio and Pricing of units (Part 1)

Fair Valuation Principles: SEBI has laid down certain principles to ensure fair treatment to all investors in a mutual fund scheme. These principles aim to provide a fair price for investments and address mispricing risk.
Key Principles:
- Valuation of investments shall be based on the principles of fair valuation, i.e., reflective of the realizable value of the securities/assets.
- The policies and procedures for valuation shall be approved by the Board of the Asset Management Company and shall identify the methodologies used for valuing each type of security.
- Assets shall be consistently valued according to the policies and procedures, with a process to deal with exceptional events where market quotations are no longer reliable.
- The asset management company shall provide for periodic review of the valuation policies and procedures to ensure appropriateness and accuracy.
Valuation Guidelines:
- Traded securities shall be valued at the last quoted closing price on the stock exchange.
- Non-traded securities shall be valued "in-good faith" by the asset management company on the basis of appropriate valuation methods.
- The value of gold and silver held by an exchange-traded fund scheme shall be valued at the AM fixing price of the London Bullion Market Association (LBMA).
Computation of Net Assets: The net assets of a mutual fund scheme are calculated by valuing the securities held in the portfolio, and the Net Asset Value (NAV) is the total value of the portfolio divided by the number of units outstanding.

Net Asset Value, Total Expense Ratio and Pricing of units (Part 2)

Net Assets: The unitholders’ funds in the scheme, which include the amount originally invested, profits booked, and appreciation in the investment portfolio.
Net Asset Value (NAV): The value of each unit of the scheme, calculated as the total assets minus liabilities other than to unitholders, divided by the number of outstanding units.
Mark to Market: The process of valuing each security in the investment portfolio at its current market value, to reflect the true worth of each unit of the scheme.

Key concepts:

Net assets increase when market prices of securities held in the portfolio increase, even if investments have not been sold and profits realized.
A scheme cannot show better profits by delaying payments, as all expenses related to a period must be considered, irrespective of whether the expense has been paid.
Any income that relates to the period will boost profits, irrespective of whether it has been actually received, following the accrual principle.

Net Asset Value Calculation

Formula 1: Unit-holders’ Funds in the Scheme (Net Assets) ÷ No. of outstanding Units
Formula 2: (Total Assets minus Liabilities other than to Unitholders) ÷ No. of outstanding Units
Example: 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

Mark to Market

Purpose: To reflect the true worth of each unit of the scheme, by valuing investments at their current market value.
Importance: Helps investors buy and sell units at fair prices, and assess the performance of the scheme/fund manager.

Total Expenses in Mutual Fund Scheme

Types of Expenses: Investment and Advisory Fees, Recurring Expenses, and other expenses.
Recurring Expenses: Include marketing and selling expenses, brokerage and transaction cost, registrar services, fees and expenses of trustees, audit fees, custodian fees, and more.
Total Expense Ratio: The ratio of total expenses to the average net assets of the scheme, excluding issue or redemption expenses.

Net Asset Value, Total Expense Ratio and Pricing of units (Part 3)

Total Expense Ratio (TER): The TER of a mutual fund scheme includes all expenses incurred by the scheme, such as investment management and advisory fees, and is subject to certain limits.
TER Limits: The TER limits vary depending on the type of scheme, such as fund of funds, index funds, and open-ended schemes, and are based on the daily net assets of the scheme.
Expense Ratio Slabs: The TER limits are slab-based, with lower TER limits for larger assets under management, and are as follows:
- For fund of funds schemes:
  - Investing in liquid schemes, index funds, and ETFs: 1.00% of daily net assets
  - Investing in equity-oriented schemes: 2.25% of daily net assets
  - Investing in other schemes: 2.00% of daily net assets
- For index fund schemes and ETFs: 1.00% of daily net assets
- For open-ended schemes:
  - Equity-oriented schemes: 2.25% of daily net assets (up to Rs. 500 crores), 2.00% (next Rs. 250 crores), and lower slabs for larger assets
  - Other schemes: 2.00% of daily net assets (up to Rs. 500 crores), 1.75% (next Rs. 250 crores), and lower slabs for larger assets
Additional Expenses: Mutual funds can charge additional expenses, such as brokerage and transaction costs, and expenses for distribution and marketing, subject to certain limits.
Valuation of Perpetual Bonds: SEBI has imposed limits on the exposure of mutual funds to perpetual bonds, such as AT1 and AT2 bonds, and has specified valuation guidelines for these bonds.
Distributable Reserves: Dividends can be paid out of distributable reserves, which are calculated based on accrued income and expenses, and ignore valuation gains, but adjust for valuation losses.
Dividend Payment: The trustees decide the quantum of dividend and the record date, and the NAV is adjusted at the end of the record date to reflect the payout of the dividend.

Net Asset Value, Total Expense Ratio and Pricing of units (Part 4)

Dividend Declaration: The AMC shall issue a public communication giving the details of the dividend, including the record date, within one day of the trustees' decision. The record date shall be five calendar days from the issue of the notice.
Record Date: The date by which investors must be registered as unit holders to be eligible for dividend payment.
Notice Requirements: The public notice should clearly state that the NAV will decline pursuant to the pay-out of income distribution cum capital withdrawal plan and any statutory levy.
Exemptions from Notice: Schemes/plans such as liquid schemes or other debt schemes with dividend distribution frequency ranging from daily to monthly are exempt from the notice requirement.
Listed Schemes: Listed schemes shall follow the requirements stipulated in the listing agreement for the purpose of declaring and distributing dividends.
Dividend Distribution: There is no assurance or guarantee to unitholders as to the rate or quantum of dividend distribution that it will be paid regularly.

Entry and Exit Load

Entry Load: A charge levied on investors when they invest in a mutual fund scheme. Entry loads are no longer permitted.
Exit Load: A charge levied on investors when they redeem their units from a mutual fund scheme. The difference between the NAV and re-purchase price is called the exit load.
Load Structure: Schemes can calibrate the load when investors offer their units for re-purchase, incentivizing investors to hold their units longer by reducing the load as the unit holding period increases.

Key Accounting and Reporting Requirements

Account Maintenance: The accounts of the schemes need to be maintained distinct from the accounts of the AMC.
Auditor Requirement: The auditor for the AMC has to be different from that of the schemes.
NAV Calculation: NAV is to be calculated up to 4 decimal places in the case of index funds, liquid funds, and other debt funds, and up to at least 2 decimal places for equity and balanced funds.
Fractional Units: Investors can hold their units even in a fraction of 1 unit.

NAV, Total Expense Ratio, and Pricing of Units for Segregated Portfolio

Segregated Portfolio: A portfolio comprising debt or money market instruments affected by a credit event, which has been segregated in a mutual fund scheme.
Investment and Advisory Fees: AMC shall not charge investment and advisory fees on the segregated portfolio.
TER: TER (excluding the investment and advisory fees) can be charged on a pro-rata basis only upon recovery of the investments in the segregated portfolio.
NAV Disclosure: The Net Asset Value (NAV) of the segregated portfolio shall be declared on a daily basis, with adequate disclosure in all scheme-related documents.