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Valuation Norms – NAV Calculation Principles

Introduction

The Net Asset Value (NAV) is the single most important number for mutual fund investors—it determines the price at which units are bought and sold. To ensure fairness and consistency, SEBI has prescribed detailed valuation norms that specify exactly how each type of security in the mutual fund portfolio must be valued daily. These standardized methodologies prevent AMCs from manipulating NAVs and ensure all investors transacting on the same day get the same fair price.

Core Valuation Principle

The fundamental principle underlying all valuation norms is fair market value—the price at which an asset would change hands between a willing buyer and willing seller in an arm's length transaction under normal market conditions. This ensures that the NAV reflects the true realizable value of the portfolio at any given point in time.

Valuation of Equity Securities

1. Listed Equity Shares (Traded on Stock Exchanges)

Listed equity shares that are actively traded must be valued at the closing price on the principal stock exchange where the security has the highest trading volume on the valuation date.

Process:

If the stock traded on the valuation date, use the closing price from NSE or BSE (whichever has higher volume for that stock)
The closing price is the weighted average price of all trades in the last 30 minutes of trading (3:00 PM to 3:30 PM)
This closing price is applied uniformly to all units of that stock held in the portfolio

Example:

A scheme holds 10,000 shares of Reliance Industries
On March 15, 2024, Reliance closed at ₹2,850 on NSE (with higher volume than BSE)
Valuation = 10,000 × ₹2,850 = ₹2,85,00,000

2. Thinly Traded or Suspended Securities

For stocks that did not trade on the valuation date or are suspended from trading, special rules apply:

If No Trading on Valuation Date:

Use the last available closing price from the most recent trading day
However, if there's no trading for more than 30 days, the security must be valued by an independent valuer at estimated fair value

If Suspended from Trading:

Initially use last trading day price
After 30 days of suspension, get independent valuation
Haircut (discount) may be applied based on liquidity concerns

3. Unlisted Equity Shares

Unlisted equity shares (not traded on any exchange) are valued at fair value determined by an independent valuer appointed by the Board of Trustees. The valuer typically uses methods like:

Discounted Cash Flow (DCF) analysis
Comparable company multiples (P/E, P/B ratios of similar listed companies)
Net Asset Value method for investment holding companies

The valuation must be updated at least once every six months or more frequently if significant events occur (like funding rounds, exits, or business deterioration).

Valuation of Debt Securities

Debt securities valuation is more complex because bonds don't trade actively on exchanges like stocks. The methodology depends on the type of debt instrument:

1. Government Securities (G-Secs) and Treasury Bills

Government securities and treasury bills are valued using prices published by agencies approved by SEBI:

CRISIL (Credit Rating Information Services of India Limited)
FIMMDA (Fixed Income Money Market and Derivatives Association of India)

These agencies publish daily bond prices based on actual market transactions, dealer quotes, and yield curve modeling. AMCs must use these published prices, ensuring consistency across all mutual funds.

Example:

Scheme holds ₹1 crore face value of 7.26% G-Sec maturing in 2029
CRISIL publishes price at ₹102.50 (per ₹100 face value) on valuation date
Portfolio value = (₹1,00,00,000 / 100) × 102.50 = ₹1,02,50,000

2. Corporate Bonds and Debentures

Corporate bonds are also valued using prices from CRISIL or other SEBI-approved agencies. These agencies consider:

Credit rating of the issuer (AAA, AA, A, BBB, etc.)
Remaining maturity of the bond
Coupon rate vs current market yield
Liquidity premium for thinly traded bonds

Rating Impact: Lower-rated bonds (like BBB or below) trade at lower prices (higher yields) compared to AAA-rated bonds of similar maturity, reflecting higher credit risk.

3. Money Market Instruments

Short-term instruments like Commercial Paper (CP), Certificate of Deposit (CD), and short-term debentures (maturity < 60 days) are typically valued using the amortized cost method rather than mark-to-market:

Amortized Cost Method:

The security is initially recorded at acquisition cost
The difference between acquisition cost and redemption value is amortized (spread) evenly over the remaining life
Daily valuation increases gradually from cost to redemption value along a straight line

Example:

Purchased 91-day Commercial Paper at ₹98.50 (discount to face value ₹100)
Total discount to be amortized = ₹100 - ₹98.50 = ₹1.50
Daily amortization = ₹1.50 / 91 = ₹0.0165 per day
On day 30, valuation = ₹98.50 + (30 × ₹0.0165) = ₹98.995

This method is allowed because short-maturity instruments have minimal interest rate risk and are typically held to maturity.

Valuation of Other Assets

1. Mutual Fund Units (Fund of Funds)

When a mutual fund scheme invests in units of other mutual funds (called Fund of Funds), those units are valued at the latest available NAV of the underlying fund on the valuation date.

2. Derivatives (Futures and Options)

Derivative contracts are marked-to-market daily using:

Exchange-traded derivatives: Closing price/settlement price from the exchange (NSE/BSE)
OTC derivatives: Fair value based on standard pricing models (Black-Scholes for options, carry cost for forwards)

3. Foreign Securities

Securities traded on foreign stock exchanges are valued at:

Closing price on the foreign exchange (in foreign currency)
Converted to Indian Rupees using the RBI reference rate for that currency on the valuation date

Example:

Holds 100 shares of Apple Inc. traded on NASDAQ
Apple closed at $175 on valuation date
RBI reference rate: USD 1 = ₹83
Valuation = 100 × $175 × 83 = ₹14,52,500

NAV Calculation Formula and Timeline

3:30 PM: Market Close"Stock exchange closing prices finalized"

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4:00 PM: Portfolio Valuation"Apply valuation norms to all holdings (equity at closing, debt at CRISIL prices)"

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5:00 PM: Income/Expense Accrual"Add accrued interest, dividends; deduct daily expense ratio"

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6:00 PM: NAV Computation"(Total Assets - Total Liabilities) ÷ Outstanding Units"

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7:00 PM: Compliance Review"Internal audit checks calculations"

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9:00 PM: NAV Publication"Published on AMC website, AMFI portal (SEBI deadline)"

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NAV Formula:

NAV per unit = (Market Value of Portfolio + Cash + Accrued Income - Accrued Expenses - Liabilities) / Total Outstanding Units

Case Study: Correction of Valuation Error

❗ Scenario:

In March 2021, a mid-sized debt fund AMC used incorrect bond prices for valuing certain corporate bonds in its ultra-short duration fund. Instead of using CRISIL's published price of ₹101.20, the AMC's operations team mistakenly used ₹102.80 (from an outdated file) for bonds worth ₹50 crore in the portfolio.

💡 Analysis:

The error inflated the portfolio value by ₹50 Cr × (102.80 - 101.20) / 100 = ₹80 lakh. This resulted in an overstated NAV. Investors who bought units on that day paid more than fair value, while those who redeemed received more than they deserved. The error was discovered during monthly reconciliation.

✅ Outcome:

SEBI directed the AMC to: (1) Correct the NAV for the affected dates (2) Compensate investors who transacted at incorrect NAV—buyers refunded the excess paid, sellers asked to return the excess received (3) Pay penalty of ₹25 lakh for valuation process failure (4) Strengthen internal controls with dual verification of valuations.

🎓 Key Learnings:

Valuation errors, even unintentional, can unfairly benefit some investors at others' expense
AMCs must use only SEBI-approved sources (CRISIL/FIMMDA) for bond pricing
Daily dual-verification of valuations prevents errors
SEBI can order NAV correction and investor compensation for valuation lapses

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Comparison: Different Valuation Methods

Mark-to-Market (Equity, Listed Debt)

Uses current market prices daily
Reflects real-time changes in asset values
NAV can be volatile (fluctuates with market)
Suitable for liquid, actively traded securities
Example: Listed stocks valued at closing price
Fair for high liquidity assets where price discovery happens daily

Amortized Cost (Short-term Money Market)

Uses cost plus straight-line amortization
Values converge gradually to redemption value
NAV is stable (minimal daily fluctuation)
Suitable for hold-to-maturity short-term instruments
Example: 90-day CP valued at cost + daily amortization
Appropriate for low-risk, short-maturity instruments

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SEBI's Periodic Review of Valuation Norms

SEBI periodically reviews and updates valuation norms based on market developments:

Recent Updates:

2020: Swing pricing introduced for debt funds (allows AMCs to adjust NAV to pass on transaction costs to large redeemers, protecting existing investors)
2021: Side-pocketing norms (segregating bad/illiquid assets into separate portfolio with separate NAV)
2022: Enhanced disclosure on security-wise valuations in monthly factsheets

Exam Notes: Writing the Answer

Question: "Explain SEBI's valuation norms for securities held in mutual fund portfolios." (10 Marks)

Model Answer:

SEBI has prescribed detailed valuation norms to ensure fair and consistent NAV calculation across all mutual funds.

Equity Securities:

Listed & Traded Stocks: Valued at closing price on the principal stock exchange (NSE/BSE with higher volume). Closing price is the weighted average of last 30 minutes of trading.
Thinly Traded Stocks: Use last available trading day price. If no trading for 30+ days, use independent valuer's fair value estimate.
Unlisted Equity: Fair value determined by independent valuer using DCF, comparable multiples, or NAV method. Updated minimum every 6 months.

Debt Securities:

Government Securities: Valued using prices published by SEBI-approved agencies (CRISIL, FIMMDA) based on market transactions and yield curves.
Corporate Bonds: Valued using CRISIL/agency prices that incorporate credit rating, maturity, coupon rate, and liquidity premium.
Money Market Instruments (maturity < 60 days): Valued using amortized cost method—purchase cost plus daily straight-line amortization to redemption value. This provides stable NAV for short-maturity, hold-to-maturity instruments.

Other Assets:

Mutual Fund Units (FoF): Latest NAV of underlying fund
Derivatives: Exchange closing price or fair value using pricing models
Foreign Securities: Foreign closing price converted at RBI reference exchange rate

NAV Calculation: (Market Value of Portfolio + Cash + Accrued Income - Expenses - Liabilities) / Outstanding Units. Must be published by 9 PM daily.

Example: Bond valuation error in 2021 where AMC used wrong price (₹102.80 vs correct ₹101.20) overstated NAV, required NAV correction and investor compensation by SEBI.

Summary

Core Principle: Fair market value for all securities ensures investors transact at true realizable prices
Listed Equity: Closing price from principal exchange (last 30-min weighted average)
Unlisted Equity: Independent valuer's fair value (updated every 6 months minimum)
Government Bonds: CRISIL/FIMMDA published prices based on market yields
Corporate Bonds: Agency prices reflecting rating, maturity, liquidity
Money Market (< 60 days): Amortized cost method (cost + daily straight-line amortization)
NAV Formula: (Assets - Liabilities) / Units, published by 9 PM daily
Valuation Errors: SEBI can order NAV correction and investor compensation

Quiz Time! 🎯

Test Your Knowledge

Question 1 of 4

1. Listed equity shares are valued at:

Opening price of the day

Closing price (weighted average of last 30 min trading)

Average of high and low prices

Previous day's closing price

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Valuation Norms – NAV Calculation Principles

Introduction

Core Valuation Principle

Valuation of Equity Securities

1. Listed Equity Shares (Traded on Stock Exchanges)

2. Thinly Traded or Suspended Securities

3. Unlisted Equity Shares

Valuation of Debt Securities

1. Government Securities (G-Secs) and Treasury Bills

2. Corporate Bonds and Debentures

3. Money Market Instruments

Valuation of Other Assets

1. Mutual Fund Units (Fund of Funds)

2. Derivatives (Futures and Options)

3. Foreign Securities

NAV Calculation Formula and Timeline

Case Study: Correction of Valuation Error

📋 Case Study: Bond Valuation Error Impact

Comparison: Different Valuation Methods

Mark-to-Market (Equity, Listed Debt)

Amortized Cost (Short-term Money Market)

SEBI's Periodic Review of Valuation Norms

Exam Notes: Writing the Answer

Summary

Quiz Time! 🎯

Test Your Knowledge

📋 Case Study: Bond Valuation Error Impact

Mark-to-Market (Equity, Listed Debt)

Amortized Cost (Short-term Money Market)

Test Your Knowledge