NAV, Total Expense Ratio and Pricing — where the number comes from

The problem this chapter solves

A scheme's ownership changes every day. Some investors buy, some redeem, and the rest stay. Every one of those transactions happens at a price — and if that price is wrong, somebody is quietly transferring wealth to somebody else.

That is why SEBI laid down fair valuation principles. Their stated purpose is to ensure fair treatment to all investors — existing holders, buyers and redeemers alike, at all points of time — and to address mispricing risk and reduce the vulnerability of short-term debt-oriented schemes to redemption pressure.

Valuation follows the Seventh Schedule of the SEBI (Mutual Funds) Regulations, 2026.

The ten fair valuation principles, in plain terms

You do not need all ten verbatim, but four of them carry marks:

Principle 1 — fair value means realisable value. Valuation must reflect what the securities could actually be sold for, done in good faith and in a true and fair manner.

Principle 4 — independent review at least annually. Policies and procedures must be reviewed at least once in a financial year by an independent auditor, and the Boards of the Trustee and the AMC updated at appropriate intervals.

Principle 6 — disclosure in the SAI. The valuation policy and procedures must be disclosed in the Statement of Additional Information, on the AMC's/fund's website, and anywhere else SEBI specifies.

Principle 7 — the AMC owns the outcome. The responsibility for true and fair valuation and correct NAV is the AMC's, irrespective of the disclosed policies. If following the stated policy would produce an unfair valuation, the AMC must deviate from it to reach fair value — with reporting to both Boards and disclosure to investors.

Read Principle 7 again. It closes the excuse "we followed our policy". The policy is not a defence if the answer was wrong.

And a tie-breaker worth remembering: where the Principles of Fair Valuation conflict with SEBI's Valuation Guidelines, the Principles prevail.

Valuing the securities

Traded securities (other than money market and debt) — valued at the last quoted closing price on the exchange. Where traded on more than one exchange, use the exchange where the security is principally traded; the AMC selects it but must record the reasons in writing, and must also record reasons for any change of exchange.

If not traded on the selected exchange on a valuation day, use another exchange's price. If not traded anywhere that day, use the earliest previous day's price — provided that date is not more than thirty days before the valuation date.

Non-traded securities — a scrip not traded on any stock exchange for thirty days before the valuation date is treated as non-traded. It is valued "in good faith" by the AMC on Board-approved principles, documented in Board minutes, with supporting data preserved. The methods are periodically reviewed by the trustees and reported on by the auditors as "fair and reasonable" in the annual accounts.

Note the same thirty-day figure does two jobs: it is the look-back limit for a traded security's last price, and the threshold beyond which a security becomes non-traded.

Gold — valued at the LBMA AM fixing price in US dollars per troy ounce, fineness 995.0 parts per thousand. Silver — same basis, fineness 999.0 parts per thousand.

Computing net assets and NAV

Work through the workbook's own example. Investors bought 20 crore units at ₹10, so the scheme mobilised ₹200 crore. ₹140 crore went into equities and appreciated 10%. ₹60 crore went into bank deposits and money market instruments. Interest and dividend received: ₹8 crore. Expenses paid: ₹4 crore. Expenses payable: ₹1 crore.

NAV = Net assets ÷ units outstanding = 217 ÷ 20 = ₹10.85

Or equivalently: (Total assets − liabilities other than to unitholders) ÷ units = (218 − 1) ÷ 20 = ₹10.85

Four things follow from that table:

• Net assets include the amount originally invested, the profits booked, and the appreciation in the portfolio
• Net assets rise when market prices rise, even if nothing has been sold
• A scheme cannot flatter its profits by delaying payments — every expense relating to a period counts, paid or not. That is the accrual principle
• Equally, income relating to the period boosts profits whether or not it has reached the bank

So NAV rises with higher interest, dividend and capital gains, with higher portfolio appreciation, and with lower expenses.

The profitability equation:

Mark to market — why it exists

Mark to market means valuing every security at its current market value.

Why bother? Because without it, a share bought at ₹15 and now worth ₹50 would still be carried at ₹15. If the scheme sold it, it would recover ₹50, not ₹15. A NAV that ignores that is simply not the true worth of a unit.

The workbook's demonstration of what goes wrong is worth following carefully, because it shows that mispricing is not a theoretical concern — it is a direct transfer between investors.

Take a scheme with unit capital ₹1,00,000, face value ₹10, 10,000 units, and net assets of ₹1,50,000. True NAV = ₹15.

Case 1 — a new investor buys 100 units at face value ₹10 instead of ₹15. Unit capital becomes ₹1,01,000; units become 10,100; net assets become ₹1,51,000. New NAV = 1,51,000 ÷ 10,100 = ₹14.95

The NAV fell for everyone. The incoming investor paid ₹10 for something worth ₹15, and the existing investors funded the difference.

Case 2 — an investor redeems 100 units at ₹10 instead of ₹15. Unit capital becomes ₹99,000; units become 9,900; net assets become ₹1,49,000. New NAV = 1,49,000 ÷ 9,900 = ₹15.05

The NAV rose for those remaining. The departing investor took ₹10 for something worth ₹15, and left the difference behind.

Neither case involves fraud. Both are pure arithmetic — and both are exactly what mark-to-market pricing prevents. It also makes performance measurement meaningful, since you can only judge a fund manager against values that are real.

The Total Expense Ratio

All expenses must be clearly identified and paid from the scheme. Anything in excess of the base limits is borne by the AMC, the trustees or the sponsors — not by you.

Recurring expenses that may be charged include: marketing and selling expenses including distribution commission; brokerage cost for executing trades; registrar services; trustees' fees and expenses; audit fees; custodian fees; investor communication; fund transfer costs; account statements and IDCW/redemption payouts; insurance premium; winding-up costs; statutory advertisements; storage and handling of physically settled commodities, gold and silver; and listing fees where listed.

Classification rule: a scheme (other than an index fund or ETF) whose SID says it will invest a minimum of 65% of net assets in equity and equity related instruments counts as equity-oriented for TER limits.

The TER slabs — open-ended schemes

Notice what the slab structure does: the bigger the scheme, the lower the permitted expense ratio. That is economies of scale being passed to investors by regulation rather than by goodwill.

Other TER ceilings

For a fund of funds, the TER charged over and above the weighted average of the underlying schemes' TER shall not exceed two times that weighted average — subject to the overall ceilings.

On top of the base limits

• Brokerage and transaction cost for executing trades: up to 0.06% of trade value for cash market transactions and 0.02% for derivatives
• No charges other than base expense ratio, brokerage cost, transaction cost, statutory levy and exit load may be charged to investors

And as in Chapter 5: TER must be disclosed daily, scheme-wise and date-wise, on the AMC's and AMFI's websites in downloadable spreadsheet format.

Perpetual bonds — the AT1 rules

Banks issue Additional Tier 1 (AT1) and Tier 2 bonds that are perpetual and absorb losses before equity. SEBI capped exposure:

• No mutual fund may own more than 10% of such bonds of a single issuer
• A scheme may not invest more than 10% of its assets in such instruments
• A scheme may not invest more than 5% of its assets in such instruments of a single issuer

Existing excess holdings were grandfathered, with no further investment permitted.

Deemed residual maturity for valuation moved along a glide path, reaching 100 years from the date of issuance for AT1 bonds from 1 April 2023 onwards; AT2 bonds use contractual maturity.

Two consequences follow. Close-ended debt schemes cannot invest in perpetual bonds at all, because they may only hold instruments maturing before the scheme's end date, and a 100-year deemed maturity fails that test. And if the issuer does not exercise the call option on the call date, valuation reverts to that 100-year maturity — and if the non-exercise is due to financial stress or bad news, that must be reflected in the valuation.

AT1 bonds are valued on a Yield to Call basis.

Dividends can only come from realised profits

Here is the distinction the chapter turns on.

Accrued income is receivable — it is only a question of time. Accrued expense is payable — again only time.

But valuation gains may never become real gains. It is not just a question of time; the securities have to actually be sold for the gain to be realised.

So SEBI's rule for distributable reserves:

• All profits earned (on accrual) are available for distribution
• Valuation gains are ignored — but valuation losses must be adjusted against profits
• That portion of the sale price of new units attributable to valuation gains is not available as a distributable reserve

That is deliberately conservative: gains you have not banked cannot be paid out, but losses you have not crystallised still count against you. The result is that dividend is paid out of real and realised profits, after providing for all possible losses.

Who decides, and when:

• Trustees decide the quantum and record date. For dividends up to monthly frequency, they may delegate to AMC officials, to be ratified at the next Board meeting
• Within one day of the trustees' decision, the AMC issues a public communication with the details including the record date
• The record date shall be five calendar days from the issue of the notice
• The notice must state clearly that NAV will decline by the payout and any statutory levy
• Failure to pay by the stipulated time attracts interest on the delayed payment, from the record date
• No notice is required for liquid schemes or other debt schemes with daily to monthly distribution frequency, provided the SID discloses this

A part of the sale price of investments representing realised gains is credited to an equalisation reserve, which can be used to pay dividends. And investors must be told that their dividend includes part of their capital — funds must clearly distinguish how much of the distributable surplus is NAV appreciation and how much is capital distribution.

There is no assurance or guarantee about the rate, quantum or regularity of dividend.

Entry load is banned; exit load is not

Entry load was the excess of Sale Price over NAV. SEBI has banned it, so Sale Price = NAV.

Exit load is the shortfall of Repurchase Price below NAV, and remains permitted. At NAV ₹11 with a 1% exit load, the repurchase price is 11 − 0.11 = ₹10.89.

Loads may be calibrated by holding period to encourage longer holding — 3% in year 1, 2% in year 2, and so on.

The current rules:

• No distinction between unitholders based on the amount of subscription when charging exit load
• Any imposition or enhancement of load applies only to prospective investments
• Parity among unitholders on exit load applies at portfolio level
• No exit load on bonus units or units allotted on reinvestment of dividend
• Exit loads must be credited back to the scheme immediately — they are not available to the AMC to meet selling expenses

That last point is the important one. An exit load is not a fee the fund house pockets; it goes back into the scheme, benefiting the investors who stayed.

Accounting and reporting essentials

• Scheme accounts maintained separately from AMC accounts, and the scheme auditor must differ from the AMC auditor
• NAV to 4 decimal places for index funds, liquid funds and other debt funds
• NAV to at least 2 decimal places for equity and balanced funds
• Investors may hold fractional units, though exchange trading systems may restrict transactions to whole units

Segregated portfolios — the pricing rules

When a credit event triggers a side pocket:

• The AMC shall not charge investment and advisory fees on the segregated portfolio
• TER excluding investment and advisory fees may be charged on a pro-rata basis only upon recovery of the investments in the segregated portfolio
• The NAV of the segregated portfolio must be declared daily
• Adequate disclosure must appear in all scheme related documents, monthly and half-yearly portfolio disclosures, and the annual report

The principle is fair: the fund manager is no longer managing that defaulted paper actively, so he should not charge a management fee on it — and any recovery costs come only out of what is actually recovered.