Net Asset Value,Total Expense Ratio and Pricing of Units: Comprehensive Study Guide
Understanding the financial mechanics of mutual funds is critical for any distributor. This section covers how schemes are valued, the costs involved in managing them, and how unit prices are determined based on regulatory frameworks.
Fair Valuation Principles and Norms
Asset Management Companies (AMCs) must compute the valuation of scheme investments following the Eighth Schedule of SEBI (Mutual Funds) Regulations, 1996.
- Core Objective: The primary goal is to ensure fair treatment for all investors, whether they are existing unit-holders or those entering/exiting the scheme.
- Valuation Process: A scheme’s portfolio includes various securities like equity, debt, money market instruments, gold, and real estate. The Net Asset Value (NAV) depends entirely on the current value of these underlying assets, calculated according to SEBI and AMFI guidelines.
Understanding Net Asset Value (NAV) and Mark to Market
Net Asset Value (NAV) represents the true worth of a single unit of a mutual fund scheme.
The NAV Formula
To maintain clarity for digital readers, the formula is expressed in a simple line format: NAV = (Current value of investments held + Income accrued + Current assets – Current liabilities – Accrued expenses) / No. of outstanding units.
Mark to Market (MTM)
- Definition: This is the process of valuing every security in a scheme’s portfolio at its current market value.
- Purpose: Since investors buy or redeem units based on the NAV, MTM ensures the NAV reflects the most recent market data.
Total Expense Ratio (TER) and Fund Expenses
Managing a mutual fund involves various costs that are charged to the scheme, ultimately impacting the NAV.
Types of Expenses
- Investment and Advisory Fees: Fees charged by the AMC for managing the fund, fully disclosed in the Scheme Information Document (SID).
- Recurring Expenses: These include audit fees, marketing and selling expenses, custodian fees, and registrar fees. These are charged as a percentage of the scheme’s Assets Under Management (AUM).
SEBI-Prescribed TER Limits
The Total Expense Ratio (TER) represents the recurring expenses charged to a mutual fund scheme, subject to the maximum limits prescribed by SEBI. The applicable TER limit varies based on the scheme category and the AUM slab.
| AUM Slab (₹ Crore) | Equity-Oriented Schemes | Other Than Equity-Oriented Schemes |
|---|---|---|
| First ₹500 crore | 2.25% | 2.00% |
| Next ₹250 crore | 2.00% | 1.75% |
| Next ₹1,250 crore | 1.75% | 1.50% |
| Next ₹3,000 crore | 1.60% | 1.35% |
| Next ₹5,000 crore | 1.50% | 1.25% |
| Next ₹40,000 crore | Reduced by 0.05% for every ₹5,000 crore increase | Reduced by 0.05% for every ₹5,000 crore increase |
| Balance of assets | 1.05% | 0.80% |
Important: The above slab-based limits are the prescribed TER limits for the respective scheme categories. The applicable limit should always be considered along with the latest SEBI Mutual Fund Regulations and applicable circulars/master circulars, as SEBI may revise the framework.
Exam Tip: As the AUM of a mutual fund scheme increases, the permissible TER generally decreases, resulting in economies of scale for investors.
Pricing of Units: Loads and Pricing Mechanics
The price at which an investor buys or sells units is directly linked to the NAV, adjusted for any applicable "loads".
Entry and Exit Loads
- Entry Load: Historically, this was a charge added to the NAV when purchasing units. Currently, SEBI has banned entry loads; therefore, the Purchase Price must equal the NAV.
- Exit Load: A charge deducted from the NAV when an investor redeems units. This makes the Repurchase Price lower than the NAV.
Dividends and Accrual Principle
- Accrual Principle: Income (like interest or dividends from underlying stocks) and expenses are accounted for when they are due, even if the actual cash has not been received or paid yet.
- Impact on NAV: When a scheme declares a dividend, the NAV of the scheme decreases by the amount of the dividend and any applicable taxes.
Key Takeaways for Professionals
- Transparency: All fees and advisory charges must be clearly identified and disclosed in the SID.
- Investor Protection: Valuation norms are designed to prevent any set of investors from gaining an unfair advantage over others.
- Distributor Revenue: Additional commission is sometimes allowed for promoting funds in B-30 (Beyond the top 30 cities) locations to widen the investor base.
Important Terms to Remember
- Assets Under Management (AUM): The total sum of all investments made by investors in a scheme.
- Unit Capital: The total number of units issued multiplied by the face value (typically Rs. 10).
- Ex-Dividend NAV: The NAV of a scheme after it has been reduced by the dividend amount.