Chapter 12: Valuation

Valuation Principles in Liquid Asset Portfolios

While Category I and II AIFs rely heavily on periodic DCF and EBITDA multiple models for illiquid private assets, Category III AIF portfolios hold primarily exchange-traded instruments subject to continuous or periodic Mark-to-Market (MTM) valuation:

Category III Asset Valuation Hierarchy:
┌─────────────────────────────────────────────────────────────────────────────────┐
│ 1. Exchange-Traded Equities: Traded closing price on principal stock exchange   │
│    (NSE / BSE). If not traded, weighted average price across exchanges.         │
├─────────────────────────────────────────────────────────────────────────────────┤
│ 2. Exchange-Traded Futures & Options: Settlement price officially published by  │
│    the Clearing Corporation (NSCCL / ICCL) at the end of each trading session.  │
├─────────────────────────────────────────────────────────────────────────────────┤
│ 3. Sovereign Debt & Money Market: Valuation prices published daily by SEBI-     │
│    recognized valuation agencies (CRISIL, ICRA) based on sovereign yield curves.│
├─────────────────────────────────────────────────────────────────────────────────┤
│ 4. Unlisted Instruments: Level 3 fair value estimation by independent IBBI     │
│    registered valuers in accordance with Ind AS 113.                            │
└─────────────────────────────────────────────────────────────────────────────────┘

Valuation of Derivatives Contracts

• Futures Contracts: Valued at the official daily mark-to-market settlement price determined by the clearing house. Unrealized MTM gains/losses are reflected directly in cash receivables/payables.
• Options Contracts: Valued using exchange settlement prices or standard option pricing models (Black-Scholes-Merton model or binomial trees) calibrated with observable implied volatility surfaces.

Mathematical Computation of Fund NAV

The Net Asset Value (NAV) represents the net monetary worth of the fund attributable to each outstanding unit on the valuation date:

$$\text{NAV per Unit} = \frac{\text{Gross Asset Value (GAV)} - \text{Total Fund Liabilities}}{\text{Total Number of Outstanding Units}}$$

NAV Balance Sheet Architecture:
┌──────────────────────────────────────┬──────────────────────────────────────────┐
│ GROSS ASSET VALUE (GAV)              │ TOTAL FUND LIABILITIES                   │
├──────────────────────────────────────┼──────────────────────────────────────────┤
│ • Market value of long equities      │ • Derivative margin payables & MTM loss  │
│ • Market value of bonds & T-bills    │ • Accrued management fees payable        │
│ • Fair value of long options contracts│ • Accrued audit, legal, and custody fees │
│ • Cash & bank balances               │ • Accrued performance fees (if earned)   │
│ • Collateral posted with PCM / Clr.  │ • Direct taxes / TDS payable             │
└──────────────────────────────────────┴──────────────────────────────────────────┘

Frequency of NAV Strikes

• Open-Ended Schemes: NAV must be computed and communicated to investors at least monthly (and frequently weekly or daily for active liquidity).
• Close-Ended Schemes: NAV must be computed at least quarterly by an independent valuer.

Accounting for High-Water Marks across Investor Cohorts

In open-ended Category III AIFs accepting subscriptions and redemptions at periodic NAV strikes, calculating performance fees requires specialized accounting to uphold the High-Water Mark for each individual investor:

               ┌────────────────────────────────────────────────────────┐
               │    HWM Allocation Mechanisms in Open-Ended Funds       │
               └───────────────────────────┬────────────────────────────┘
                                           │
                    ┌──────────────────────┴──────────────────────┐
                    ▼                                             ▼
┌───────────────────────────────────────┐       ┌───────────────────────────────────────┐
│          SERIES ACCOUNTING            │       │         EQUALIZATION ACCOUNTING       │
├───────────────────────────────────────┤       ├───────────────────────────────────────┤
│ • Issue a new series of units         │       │ • Single unified pool of units.       │
│   (Series A, B, C...) each month.     │       │ • Incoming investors pay an           │
│ • Each series tracks its own unique   │       │   Equalization Credit (if below HWM)  │
│   NAV, purchase price, and HWM.       │       │   or receive Equalization Deficit.    │
│ • Consolidated into Lead Series at    │       │ • Technically complex, but avoids     │
│   financial year-end via rollover.    │       │   proliferating multiple unit series. │
└───────────────────────────────────────┘       └───────────────────────────────────────┘

1. Series Accounting Methodology

• When an investor enters in Month 1 at NAV ₹100, they receive Series 1 Units.
• When a new investor enters in Month 4 at NAV ₹110, they receive Series 2 Units with an initial HWM of ₹110.
• Performance fees are computed separately for each series based on its own HWM.
• At the end of the incentive period (usually year-end), after performance fees are deducted, all series that achieved new highs are converted into Lead Series units at a common NAV ratio.

2. Equalization Credit and Deficit Methodology

• Enables all investors to hold a single unified class of units.
• An investor entering when the fund is below its historic HWM pays an Equalization Credit to the fund, which is held in reserve and returned to the investor if the fund recovers, ensuring they do not get a free ride on performance fees.