Fair valuation principles
Also written Principles of fair valuation
SEBI's ten principles requiring a mutual fund to value its holdings at realisable value, in good faith, under Board-approved and disclosed policies, so every investor entering or leaving gets a fair price.
In plain language
A mutual fund scheme is owned collectively by all its unitholders, and that ownership keeps changing as people buy and redeem. Every one of those transactions happens at the NAV. If the NAV is wrong, somebody is quietly paying somebody else.
Value a bond too high, and investors who redeem walk away with more than their share while those who stay are left holding the shortfall. Value it too low, and new investors buy in cheaply at the existing investors' expense.
The fair valuation principles exist to stop that. Their primary objective, in the workbook's words, is fair treatment to all investors — existing investors as well as those seeking to purchase or redeem — in all schemes at all points of time. They also address mispricing risk and reduce the vulnerability of short-term debt-oriented schemes to redemption pressure.
AMCs must value investments in accordance with the norms in the Seventh Schedule of the SEBI (Mutual Funds) Regulations 2026.
How it works
The ten principles, condensed:
| No. | What it requires |
|---|---|
| 1 | Valuation reflects the realisable value of the securities, done in good faith and in a true and fair manner |
| 2 | Board-approved policies identify the method for each type of security; a new type of security may be bought only after its valuation method is approved by the AMC Board |
| 3 | Assets are valued consistently, with a process for exceptional events when market quotes are unreliable |
| 4 | Periodic review of the policies; the trustee and AMC boards kept updated; review by an independent auditor at least once a financial year |
| 5 | Policies address conflict of interest |
| 6 | Valuation policy is disclosed in the Statement of Additional Information, on the AMC/fund website, and wherever SEBI specifies |
| 7 | Responsibility for true and fair valuation stays with the AMC even after disclosure; if the policy does not produce fair value, the AMC must deviate, reporting to both boards and disclosing to investors |
| 8 | Policies to detect and prevent incorrect valuation |
| 9 | Documentation of the rationale, including inter-scheme transfers, preserved for audit trail |
| 10 | For debt and money market securities, consider trade prices of the same or similar security on all available public platforms |
Where the Principles of Fair Valuation conflict with SEBI's Valuation Guidelines, the Principles prevail.
The guidelines themselves then give specifics: a traded equity is valued at the last closing price on the exchange where it is principally traded; a security not traded on any exchange for 30 days before the valuation date becomes a non-traded security, valued in good faith on Board-approved methods reviewed by the trustees; gold and silver held by ETFs use the LBMA AM fixing price.
A worked example
A debt scheme has net assets of Rs 500 crore across 5 crore units, so its NAV is Rs 100. One bond in the portfolio is still carried at Rs 40 crore, but after bad news about the issuer, trades in similar paper suggest it could only be sold for Rs 30 crore. Figures are illustrative.
Fair value: net assets = Rs 490 crore, NAV = Rs 98.
Now suppose the AMC does not mark it down, and investors holding 1 crore units redeem at the stale NAV of Rs 100.
| Valued fairly (Rs 98) | Not marked down (Rs 100) | |
|---|---|---|
| Paid to redeeming investors | Rs 98 crore | Rs 100 crore |
| True net assets left | Rs 392 crore | Rs 390 crore |
| Units left | 4 crore | 4 crore |
| True NAV for those who stayed | Rs 98.00 | Rs 97.50 |
The early leavers took Rs 2 crore that belonged to the investors who stayed — 50 paise on every remaining unit. An investor who stayed with 20,000 units lost Rs 10,000 simply because the valuation was slow.
That transfer, repeated across a stressed debt market, is exactly the "redemption pressure" on short-term debt schemes that the principles were designed to reduce. Principle 7 settles who answers for it: the AMC, whatever its disclosed policy said.
Why NISM asks about it
Chapter 7 (Net Asset Value, Total Expense Ratio and Pricing of Units), section 7.1, lists all ten principles and the valuation guidelines that follow. The chapter's very first sample question asks where the valuation policy must be disclosed — the answer being the Statement of Additional Information. Expect further recall on the objective of the principles, the annual independent-auditor review, who bears responsibility for fair valuation, and which prevails when the principles and guidelines conflict.
Common exam traps
- The valuation policy is disclosed in the SAI, not in account statements or the factsheet — and it is certainly public.
- Responsibility stays with the AMC even when it has followed its disclosed policy. If the policy gives an unfair value, the AMC must deviate.
- Independent auditor review at least once a financial year, not once in three years.
- Principles prevail over the Valuation Guidelines in a conflict.
- A new type of security needs an approved valuation method first, before the scheme invests in it.
- Non-traded means no trade on any exchange for 30 days before the valuation date — not 30 trading days on one exchange.
- The objective is fair treatment of all investors — existing, incoming and outgoing — not maximising the NAV.
Check yourself
1.As per SEBI's fair valuation principles, it is mandatory to disclose the valuation policy in the:
- a)Statement of Additional Information
- b)Statement of Accounts sent to investors periodically
- c)Fund factsheet
- d)Fair valuation principles are not to be made public
Show the answer
Answer: (a) Statement of Additional Information
Principle No. 6 requires disclosure of the valuation policy and procedures — covering each category of security, the situations where each method applies, the process and methodology, and the impact of implementation — in the Statement of Additional Information, on the AMC's/mutual fund's website, and anywhere else SEBI specifies.
The purpose is stated plainly: to ensure transparency of the valuation norms adopted by the AMC.
The SAI is the right home for it because valuation norms are standardised across all schemes of the fund house, not specific to one scheme.
Where this is taught
Free preparation for NISM Series V-ARelated terms
- Net Asset ValueThe net assets of a mutual fund scheme divided by the number of units outstanding — what one unit of the scheme is worth on a given day, after every liability except the unitholders' own.
- Net assetsThe unitholders' funds in a scheme: the market value of everything it owns, plus income accrued and receivables, minus what it owes to others — the figure NAV divides by the number of units.
- TrusteesThe guardians of a mutual fund trust, who hold its property for the unitholders and oversee the AMC — at least two-thirds of them independent, each approved by SEBI in advance.
- Mark to MarketThe daily settlement of a futures position at that day's closing price, so gains and losses are paid in cash every evening instead of accumulating until expiry.
- Non-traded securityA security (other than money market and debt) not traded on any stock exchange for thirty days before the valuation date, which the AMC must then value in good faith rather than at a market price.
- Valuation agencyAn independent agency whose valuation matrix mutual funds must use to price non-traded and thinly traded debt; there have to be at least two, and AMFI has appointed CRISIL and ICRA.
- Deemed residual maturityThe maturity SEBI tells mutual funds to assume when valuing perpetual AT1 and AT2 bank bonds and computing their duration. For AT1 bonds it is 100 years from issuance from April 1, 2023.
- Capitalization of earningsA SEBI-approved method for valuing an equity holding that has not traded for 30 days — using the price-earnings ratios of comparable traded securities, discounted for its lower liquidity.
- Principally traded exchangeThe one stock exchange an AMC selects, and records its reasons for in writing, to value a security that trades on more than one exchange — used consistently until a documented change of exchange.