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Valuation and Performance Evaluation of Mutual Funds

Date post: 16-Nov-2014
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Mutual fund is calculated on the basis point of Net Asset Value of investments by funds. Distributer & Investors understand how mutual funds value the securities held in their portfolio. It is also help them anticipate the fluctuations in the portfolio value under different market scenarios and recommend or their investment decisions accordingly. It helps in comparing the performance of different fund schemes by reviewing the valuation methods followed by them.

REGULATION OF VALUATION PRACTICESAs the industry regulator, SEBI aims at protecting the investors by ensuring that the valuation practices adopted by the AMCs are: a) Based on principals of fair valuation of portfolio securities, The fair valuation ensures that realistic prices are used to compute the value of the portfolios. b) are uniform across the fund types and AMCs to the extent possible Uniform valuation practices ensure that everyone can compare the performance of different schemes and AMCs without worrying about whether the fund valuation practices may be different from one scheme to another.

AMCs therefore adopt uniform portfolio valuation practices to the extent possible, AMFI sets the industry standards on valuation. SEBI in turn regulates anda) b)

Prescribes detailed valuation methodologies in its fund regulations, Mandates disclosure of valuation methods used for information of investors


Fair value: It means value of a security that is realistic and not based on any random methodology.

Fair value of traded securities: It is traded in stock market or on the money market it ensure liquidity of the investments, it means this security can be sold. Second region is these securities receive fair valuation at market prices that are publicly available.

Fair value of illiquid securities: Valuation of non-traded securities poses a problem of how to determine their fair value. Regulators prescribe methods wherever possible or require the trustees to determine the right methodology and disclose to the extent possible.

Valuation Date: The date on which the fund calculates the value of its portfolio and the NAV is known as the valuation date. Where funds value their investments on mark-to-market basis.

Valuation of Equity Securities

The valuation principle to be used depends also upon whether a security is traded in the market or not. Traded securities : For traded securities, the basis of valuation is mark to market. Calculation of NAV: It is the market value of the assets of the scheme minus its liabilities. For example: size of the scheme= Rs. 200 crores Face value= Rs. 10 per unit value of the funds invest= 280 crores Receivables and incomes= 4 crores

liabilities and accrued expenses = 2 crores NAV= ( Receivables+ accrued income- liabilities-acc liabilities) / No. of units outstanding NAV = 282/20= 14.1 Rs. Thinly Traded Securities: An equity is considered as a thinly traded security if both (1) the trading volume in a month is less than Rs. 5 lakhs and (2) the total volume is less than 50,000 shares.

Non- traded securities : when a security is not traded on any stock exchange for 30 days prior to the valuation date, it becomes a non traded security. Valuation of Non Traded / Thinly- Traded Equity Securities : Example : company A makes Rs. 2 EPS and has a net worth of Rs. 8 per paid up share , we can use other traded engineering companies industry average for basing the P/E multiple= 12 ,

with a 75% discount , the P/E multiple applicable for untraded share= 12* 125%=3 Valuation price= 3 * 2 = 6 Rs. This is further averaged with the companys net worth of 8 to give a value of Rs. 7 per share, i.e. (6+8)/2 we must discount 7 by 10% to give a valuation of Rs. 6.30 per share.


Traded securities. Thinly-Traded securities. Valuation of non-Traded/thinly-traded debt securities.


Debt securities traded on stock exchange (corporate sec),and interbank market (generally G sec). Valued at the last quoted market price on the stock exchange where it is principally traded used for its valuation. If not traded, then take the value at which it was traded on the earliest previous day provided it is not more than 15 days prior to valuation date. If debt securities(other than Govt.securities)is purchased way of private placement,then take the value of a period of fifteen days beginning from the date of purchase.


It need to be identified and then valued especially, debt securities . Debt securities consider as a thinly traded,if on the valuation data there is no individual trade in that security in marketable lots (currently Rs.5 crores) on the principle stock exchange or other stock exchange.

VALUATION OF NON-TRADED/THINLY- TRADED DEBT SECURITIES Thinly traded is defined above would be valued as per the norms set for a non- traded debt securities. Valuation norms for such thinly/non traded debt instruments depends upon their maturity. Thus,


Non trade debt securities residual maturity upto182 days should be valued and same as money market securities. these securities are valued on the basis of amortization of purchase cost plus accrued interest till the beginning, plus diff between the redemption value and the purchase cost that uniformly over the remaining maturity period of instrument. The same proses should be adopted thus, If total of cost plus interest is 1,00,000 if muturity value will be Rs.1,20,000 and remainder maturity days 20,the difference amount is Rs.20,000. Thus ,each day security value increase Rs.20,000/20 days or by Rs.1,000,and on day maturity-5 will be Rs. 1,00,000 plus Rs.15,000 including 15 days amortization.


The non-investment grade securities are further classified as Performing and Non Performing assets. All Non-Government, non investment grade, performing debt securities are valued at a discount of 25%to face value. A Rs.100 face value securities will be priced at Rs. 75. Non performing debt securities would be valued based on the provisioning norms. All Non-Government, investment grade debt securities, are valued on yield to maturity. Example:- If fund manager expects a YTM of 10% on securities that pays coupon rate of 9% for face value of Rs.100,its value will marked down 90 so it yield will be 10%.

(C):-COMPUTATION METHODOLOGY FOR YIELDS USED FOR VALUATIONS OF DEBT SECURITIES.Yield expected on a security is key to its valuation. SEBI sets down detailed guidelines on the yield based valuation. Non traded debt securities is based on concept of using spreads over the benchmark rate to arrive at the pricing of non traded securities. STEP:-A

A Risk Free Benchmark Yield is calculated to using Gsec , GOI Sec as the base, as they are traded regularly.


The difference between the two yields is the spread over the benchmark yield.


Yield so used for valuation adjusted to reflect the illiquidity risk of a security.


The Yield so arrived for all categories of securities are used to price the portfolio. If Yields for any categories of securities cannot be obtained using any or all of the above steps, then a fund may use the credit spreads from trades on appropriate stock exchange of the relevant rating category over the AAA securities trades.

Call money, bill purchased under rediscounting and short term deposits with banks are valued at cost, plus accrued interest.


Non-convertible component is valued as a debt instrument, and convertible as any equity instrument. If, after conversion, the resultant equity instrument would be traded pari passu with an existing twhich is traded, the value of the latter instrument can be adopted after an appropriate discount for the nontradability of the instrument during the period preceding the conversion. Instrument bought on repo basis must be valued at the agreed price minus interest up to the date of resale.

VALUATION OF THE SECURITIES WITH PUT/CALL OPTIONS. 1.Securities with call option : An issuer may call a debt security and repay before maturity.

Valued at the lower of two values 1.Value obtained by valuing the security to final maturity. 2.Value obtained by valuing the security to call option date. In case of multiple call option dates, the lowest value obtained either by two methods is taken.


These are the cases where the investors have the option to redeem earlier than maturity. Valued at the higher of the two values : 1. Value obtained by valuing the security to final maturity. 2. Value obtained by valuing the security to the put option date. In case of multiple put option dates, the higher value obtained either by two methods is taken.

3.SECURITIES WITH BOTH PUT AND CALL OPTIONS ON THE SAME DAY. The securities with both Put and Call options on the same day would be deemed to mature on the Put/Call day and would be valued accordingly.


SEBI instruct that:

Aggregate value of illiquid securities of a scheme, defined as non-traded, thinly traded and unlisted equity shares, shall not exceed 15% of the total asset of an open-end scheme, and 20% of a close-end fund. Illiquid securities held in excess of the limit have to be assigned zero value. All mutual fund have to disclose as on march 31 and September 30 the scheme-wise total illiquid securities in value and percentage of the net asset while making disclosure of half yearly portfolios to the unit holders. In the list of investments, an asterisk mark shall also be given against all such investments which are recognized as illiquid securities. Mutual fund is not allowed to transfer illiquid securities internally among their schemes from October 1, 2000.


Govt. securities are valued at the prices related by the agency suggested by AMFI, currently only CRISIL.

Measuring mutual fund performance


The investors perspectiveInvestors naturally interested in tracking the value of his investment. Weather he gets an acceptable return on his investment. Investor judge correctly whether his fund is performing well or not and make the right decisions.

The advisors perspectiveAdvisers have to know how to measure and evaluate the performance of the different funds that are available to the investors. Compare the different fund performance.


Change in NAV Most Common Measure Investors compute the return on investment between two dates.

NAV change in absolute terms -: = (NAV at the end of the period) (NAV at the beginning of the period) NAV change in percentage terms -: =(absolute change in NAV / NAV at the beginning)*100 Annualized NAV change -: ={[(absolute change in NAV / NAV at the beginning) / months covered]* 12}*100 It is commonly used by investors to evaluate the fund performance. It is easily understood and applies to any type of fund. Fund easily interpreted in light of the investment objective of the fund, current market condition and alternative investment returns. It is suitable for evaluating growth funds & accumulation plans of debt & equity funds with withdrawal plans.


Total ReturnTotal Return = [(Dividend distributed + Change in NAV) / NAV at the beginning of the period]* 100

It is suitable for all type of funds. Performance of different type of funds can be compared by this. During a given period of time, you can find out whether a debt fund gave better returns than an equity fund. Performance of fund must be interpreted in the light of market condition and investment objective of the fund. It ignores the fact that distributed dividend also get reinvested if received during the year.


Return on investment or Total return with dividends reinvested at NAV -:The most suitable measures


The appropriate measure of the growth of an investors mutual fund holding is, therefore, the return on investment (ROI) on a cumulative basis over a certain time period. Total return with reinvestment is such a measure of cumulative, and is the same as ROI. = {(1 + div/ex-dNAV)*endNAV} begin NAV/ begin NAV*100

It is a measure accepted by mutual fund tracking agencies such as Credence in Mumbai & Value research in New Delhi. It is appropriate for measuring performance of accumulation plans, monthly/quarterly income schemes and debt funds that distribute interim dividends.

Return on investment or Total return with dividends reinvested at NAV -:

B. Cumulative Aggregate vs. Average Annualized Returns In India many mutual fund schemes like Unit Trust of India, are based on cumulative returns over along period, e.g., Childrens Growth Fund or Rajalaxmi Fund. The maturity value of an original investment will be: A = P*(1+R/100)^N Given -: P = Principal Invested, A = Maturity Value of investment, N = Periods of investment in years, R = Annualized compound rate in % The growth in maturity value can be converted to average annualized return as follows : R=[(Nth root of A/P) - 1)*100

Return on investment or Total return with dividends reinvested at NAV -:

C. Compare the same time period -: While computing these total return, it is imperative to use the performance data over the same time periods for two different funds being compared, as returns over different periods very due to market conditions prevalent then. D. Less than one year period -: If the fund performance data relates to a period of less than one year, it should not be annualized, except for liquid mutual funds which have a short investment horizon. E. Returns since inception In India, SEBI requires returns to be computed since the inception of a scheme, using Rs. 10 as the base amount. This method is correct as long as it is applied to no-load funds.


Purpose: It indicates funds efficiency and cost effectiveness. Formula: Total Expense/Average of Net Asset. Suitability: Important in bond or debt funds. Limitation: It doesnt hold good in case of funds with small corpus.


Purpose: It is useful measure for income oriented funds, particularly debt fund. Formula: Net Investment Income/Net Asset. Limitation: This ratio cannot be considered in isolation. It should be used only to supplement the analysis based on expense ration and total return.


Purpose: It measures the no. of times the fund manager turns over his portfolio. Formula: Lesser the Asset purchased or sold/Funds Net Asset. Suitability: It is suitable to analyze in case of equity.


Definition: It include all expenses related to trading. Suitability: It has significant bearing on fund performance and its total return. Limitation: Dealers spread is difficult to quantify in prospectus or annual report.

Fund Size: Can be identified by comparing the corpus of two funds and can distinguished as small fund or large fund. Cash Holdings: The percentage of funds portfolio held in cash equivalents. Borrowing by Mutual Fund: NOT ALLOWED in INDIA, MF can borrow for period not exceeding 6 month and to the extent of 20% of its net assets.



A funds performance can be judged with respect to investors expectations. Investors has to define his expectations in relation to certain indicators on what is possible to achieve or moderate this with comparable investment alternatives available in the market. This indicators of performance can acts as a benchmark against investors funds performance. It is very important to select the right benchmark to evaluate a funds performance.

HOW TO CHOOSE AN APPROPRIATE BENCHMARK ?Benchmark for any fund has to be selected by reference to : 1) The Asset Class in which he wants to invest ; and 2) The funds stated Investment Objective.

Historically, investors only option were UTI schemes or bank deposits. But now there are 3 types of benchmarks available 1) relative to the market as a whole, 2) relative to other mutual funds, and 3) relative to other comparable financial products or investment options open to the investor.

BENCHMARKING RELATIVE TO THE MARKET1. EQUITY FUNDS : Index Funds (a Base Index) : investor can expect the same return on his investment as the return on the equity index used by the fund as its benchmark. This is a Passive investment style. The benchmark is clear and pre-decided by the fund manager like S & P CNX Nifty Index, BSE SENSEX Index and so on.

Tracking Error : To obtain the same return, an Index fund invests in all of the stocks included in the Index calculation and also in the same proportion. Due to this, an Index Funds actual return may be better or worse. It arises from the practical difficulties faced by the fund manager.

Active Equity Funds : The Index should be decided on the basis of the size and the composition of the funds portfolio for eg. For the fund having large portfolio BSE 100 or 200 or NSE100 be used instead of S & P CNX Nifty or BSE30. An actively managed funds gives higher returns than the Index itself.

2. DEBT FUNDS : A Debt market Index should be used and depends on the kind of debt that comprises the portfolio. Different indices are available for benchmarking debt funds a) I SEC : Its I Bex index used by some analyst to track Govt. securities performance. There are 4 indices Li-bex, Mi-bex, Sibex, a Composite Index.

b) CRISIL : has 8 indices, 4 primary indices track the prices of underlying securities & 4 derived indices based on the primary indices. c) NSE : has designed a Govt. Securities Index and a Treasury Bills Index, tracks either market price movements or total return index (both interest accruals & capital gains or losses). 3. MONEY MARKET/LIQUID FUNDS : Performance is usually benchmarked against the Govt. securities of appropriate maturities because LF have portfolio of short term instruments. In India, Liquid Fund of CRISIL or NSEs G-SEC and T-Bills indices are used.

4. Appropriate Benchmarks SEBI Disclosure RequirementSEBI requires MF to specify appropriate benchmarks for each scheme in the Offer Document and Key Information Memorandum.

BENCHMARKING RELATIVE TO THE OTHER SIMILAR MUTUAL FUNDSApart from market based comparisons, it is important to measure a funds performance with other funds/schemes managed by other AMCs. In case of debt funds, it is more meaningful to compare the performance of different schemes with that of other fund managers schemes and such comparisons are called peer group comparisons. A. Criteria for Peer Group Comparisons : The investment objectives and risk profiles of two funds being compared must be same. Different equity funds/debt funds among themselves can be compared.

Portfolio compositions of two funds are similar. The credit quality and the maturity profile for the 2 debt funs both investing in corporate and govt. securities must be similar. Even when comparable on all criteria, two funds of different size may not give comparable performance. So, compare two funds only of the same size.

B. Returns of two funds with similar characteristics must be calculated on a comparable basis : Compare returns of two funds over the same period only; Only average annualized compound returns are comparable. Only after-tax returns of two different schemes should be compared.


It is essential for the investor to compare its performance with other investments products in the market. In India, investors also compare their MF returns with cumulative growth schemes such as Indira Vikas Patra, doubling the capital in a given no. of years. In such cases, firstly convert the cumulative aggregate returns to average annualized compound returns and then compare with the same returns from a MF scheme.

FUND PERFORMANCE EVALUATION AND RANKING BY EXTERNAL AGENCIESNow a days, some ready help is now available to the distributors and investors by at least two external agencies who conduct Peer Group Performance Evaluation using the appropriate criteria and also rank funds by performance during a given period.1.

Lipper Analytical Services(The Economic Times, in conjunction with the U.S. agency), publishes the fund ranking by performance each quarter.

They compute the Total Returns of each scheme and the S.D. of returns during the period as a measure of Risk. Then they compute a simple risk to return ratio, by dividing the returns percentage by the S.D. and such returns are called Risk Adjusted Returns(RAR).

The funds schemes are then ranked by the highest RAR.


CRISIL ranks both debt and equity funds, and nearly all categories of schemes.

CRSIL CPRs (Composite Performance Rankings) are released every quarter. The performance criteria used by CRISIL are also based on historical RAR. CRISIL RRR (Risk Adjusted Return Rankings) is a purely quantitative measure of scheme performance put on a monthly basis to rank fund schemes on the basis of their risk adjusted returns.

CRISIL rated debt schemes by the percentage of their portfolio held in different categories rated assets. Thus a scheme with the highest overall holding of higher-rated assets is ranked first and then allow others. The ranking is based on credit-risk, or possibility of default by the companies in the portfolio. For equity funds, firstly they compute Superior Returns Score (returns in excess of the industry average returns for the past two years) and then funds are ranked by superior returns first. Equity Funds are ranked also in terms of RAR.


The investor must evaluate the fund managers track record, how his schemes have performed over the years. We also have institutions-managed funds that have a team of managers and is different from the funds managed only by the individuals. The team approach helps offsetting bad performance by one manager with good performance from the other team members. Currently, we have mainly institution-sponsored funds either bank-sponsored, corporate-owned or govt./financial institution-owned.

AMCs and their fund managers can be judged on the basis of the consistency in the returns they obtained , and their performance record against competing or peer group managers running similar funds. CRISIL provides a Fund Management Practice Rating (or Fund House Rating) as its current opinion on overall management quality and fund management practice.