Net Asset Value, Total Expense Ratio and Pricing of Units

1Fair valuation: why it matters

Every day some investors buy units and others sell. If the scheme's investments are valued too high, sellers get too much and those who stay lose; if valued too low, the opposite happens. SEBI's fair valuation principles aim to treat all investors fairly: those coming in, those going out and those staying.

Key points: investments are valued in good faith at the price they could realistically be sold for; the AMC's board approves a valuation policy covering every type of asset before investing in it; the policy is disclosed in the SAI and on the AMC website; and if the policy does not give a fair value in a particular case, the AMC must deviate from it to reach fair value, report the deviation to its board and the trustees, and disclose it to investors.

Exam trap A disclosed policy is not a licence to use an unfair price. If it gives an unfair value, the AMC must deviate, with reporting and disclosure.

Example A bond in a scheme last traded at ₹100, but its issuer has just been downgraded and buyers will pay only ₹80. If the scheme still values it at ₹100, investors redeeming today are overpaid at the expense of those who stay.

Remember

• Goal: fairness to existing, entering and exiting investors.
• Valuation policy disclosed in the SAI and on the website.

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2Valuing the investments

• Traded shares: the closing price on the exchange where the share is principally traded, chosen by the AMC with reasons recorded.
• Shares not traded for more than 30 days: treated as non-traded and valued in good faith using methods approved by the AMC board.
• Convertible debentures (non-traded): the debt part is valued as debt and the convertible part as equity, separately.
• Gold held by gold ETFs: valued using the LBMA (London) AM fixing price for gold of 995 fineness, converted to rupees.

Net assets of a scheme include everything it owns, including unrealised gains: the amount invested, profits earned and the appreciation in the portfolio, minus what it owes.

Exam trap Net assets include unrealised appreciation; they are not just the money investors originally put in.

Example A share held by a scheme trades mostly on NSE and occasionally on BSE. The AMC values it at the NSE closing price (its principal exchange) and records why NSE was chosen.

Remember

• Principal exchange closing price for traded shares.
• Over 30 days without trading → non-traded valuation.

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3How NAV is calculated

NAV is the value of one unit. It is worked out like this:

Formula NAV = (Market value of investments + accrued income + receivables − payables − accrued expenses) ÷ Units outstanding

Two principles matter:

• Mark to market: investments are valued at current market prices every day.
• Accrual: income and expenses that belong to a period are counted in that period, even if the cash has not moved yet. A scheme cannot make its NAV look better by delaying payment of an expense.

Example A scheme holds shares worth ₹300 crore and bonds worth ₹60 crore. It has ₹3.5 crore of dividends and ₹1.2 crore of interest receivable, owes ₹2.4 crore for a purchase and ₹0.7 crore in accrued fees. Net assets = 300 + 60 + 3.5 + 1.2 − 2.4 − 0.7 = ₹361.6 crore. With 3.2 crore units, NAV = 361.6 ÷ 3.2 = ₹113.00.

Exam trap An unpaid expense for the current period is still deducted (accrual). Fair NAV matters because issuing units below NAV dilutes existing investors, and redeeming above NAV hurts those who stay.

Remember

• NAV = net assets ÷ units outstanding.
• Mark to market + accrual.

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4Total Expense Ratio (TER)

A scheme's running costs (fund management fees, RTA fees, custodian fees, marketing and distribution) are charged to the scheme and reduce NAV. SEBI caps these costs as a percentage of daily net assets. The cap falls as the scheme grows bigger, so investors share in economies of scale.

Apart from exit load, the only charges allowed are the base expense ratio, brokerage and transaction costs (within limits), and statutory levies such as GST.

Index funds and ETFs: 0.90% maximum. Close-ended and interval schemes: 1.00% (equity) / 0.80% (others). Any expense above the cap is borne by the AMC, trustees or sponsor, never the scheme.

Example An equity scheme has ₹600 crore of assets. Its maximum base expense is 2.10% on the first ₹500 crore (₹10.5 crore) plus 1.90% on the next ₹100 crore (₹1.9 crore): ₹12.4 crore a year, or about 2.07% of assets.

Exam trap A fund cannot add any charge it likes with board approval; entry loads and transaction charges are not permitted.

Remember

• TER falls as assets grow; index funds/ETFs capped at 0.90%.
• Allowed: base expense ratio, brokerage/transaction costs, statutory levies, exit load.

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5Perpetual bonds (AT1)

AT1 bonds are perpetual bonds issued by banks; they have no fixed maturity. For valuation, SEBI treats them as having a deemed maturity of 100 years from issue. Because close-ended debt schemes may only hold instruments maturing before the scheme ends, they cannot invest in AT1 bonds.

Example A bank's AT1 bond issued in 2024 is treated for valuation as maturing in 2124. A 3-year close-ended debt scheme cannot buy it because it would not mature before the scheme ends.

Remember

• AT1 deemed maturity: 100 years.
• Close-ended debt schemes cannot hold AT1 bonds.

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6IDCW and distributable reserves

IDCW (Income Distribution cum Capital Withdrawal), earlier called dividend, can be paid only out of distributable reserves. When calculating them, unrealised valuation gains are ignored, but unrealised valuation losses are deducted: a cautious approach.

The trustees decide the amount and the record date; for distributions up to monthly frequency they may delegate this to AMC officials, subject to ratification. After the decision, the AMC must announce it within one day, and the record date is five calendar days after the notice.

An IDCW pay-out may include part of the investor's own capital, and the NAV falls by the amount paid out.

Example NAV is ₹25 and the scheme pays an IDCW of ₹2 per unit. After the record date, NAV falls to about ₹23. The investor has ₹2 in cash and a unit worth ₹23, so total wealth is unchanged (before tax).

Exam trap IDCW is not extra profit and is not guaranteed; NAV falls by the amount paid.

Remember

• Ignore unrealised gains; deduct unrealised losses.
• Announce within 1 day; record date 5 calendar days later.

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7Entry load and exit load

Entry loads are banned, so you buy at NAV (plus stamp duty). An exit load may be charged if you redeem early; it is credited back to the scheme.

Formula Redemption price = NAV × (1 − exit load)

Example NAV is ₹50 and the exit load is 1%. The investor receives ₹50 × 0.99 = ₹49.50 per unit.

Exit load does not apply to bonus units or units allotted through IDCW reinvestment. If an AMC raises the exit load, the higher load applies only to investments made after the change.

Remember

• No entry load: buy at NAV.
• Exit load credited to the scheme; not on bonus or reinvested units.
• Load increases apply only to new investments.

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8Accounting and reporting

Schemes keep separate accounts and follow the accrual principle. NAV is calculated to at least 2 decimal places for equity schemes and 4 decimal places for debt, liquid and index schemes. Each expense head above 10% of total expenses is shown separately.

Example A scheme's audit fee is ₹2 lakh for the year. Even if the bill is paid only next year, the expense is charged daily through this year, so NAV reflects it as it is incurred.

Remember

• Separate accounts per scheme; accrual basis.

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9Segregated portfolios: NAV and charges

When a debt scheme creates a segregated portfolio after a credit event, the bad security moves to a separate portfolio with its own NAV. No investment and advisory (management) fee may be charged on it. Other expenses can be charged only in proportion to any recovery.

Example A ₹20 crore bond defaults and is moved to a segregated portfolio. The AMC earns no management fee on it. If ₹8 crore is later recovered, the related costs are charged in proportion to that recovery.

Remember

• Segregated portfolio: no management fee; other costs pro-rata on recovery.

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