Net Asset Value, Total Expense Ratio and Pricing of Units

Everything an investor pays and everything an investor earns passes through a single number that is published once a day. This unit is about how that number is built: what the scheme's holdings are worth, what has been charged against them, and what an investor actually pays or receives when units change hands. It is one of the heavier units in the syllabus, and unusually for this paper almost all of it is arithmetic with rules attached — get the sequence right and the questions stop being memory work. The computation itself is the place to start.

How is NAV computed?

Take everything the scheme owns — securities at their current value, plus accrued income and cash. Subtract what it owes, including accrued expenses. Divide by the units outstanding. That is the NAV, and it is worked out at the end of every business day.

Securities are valued mark to market: at what they are worth today, not what the scheme paid for them. This is why NAV moves even when the fund manager does nothing at all. It is also why NAV is a measure of value rather than of performance — to judge performance you need two NAVs and the time between them.

What does the expense ratio do?

Running a scheme costs money: the management fee, custody, registrar charges, audit, marketing, and distributor commission where there is a distributor. Those costs are charged to the scheme, and the total is expressed as the total expense ratio, a percentage of net assets.

The part that matters for the examination and for explaining it to an investor is that it is charged daily and is already reflected in the NAV. Nobody sends the investor a bill. The return an investor sees is a return after expenses, which is why comparing two schemes on their published returns already accounts for the difference in what they charge.

SEBI caps the ratio, and the cap steps down as a scheme grows — bigger funds must pass some of their scale on. The slabs themselves have been revised more than once, so treat the current figures as something to look up.

Entry load, exit load and what an investor actually pays

There is no entry load on any mutual fund scheme in India. SEBI removed it, and the Master Circular still says so in a single line. The consequence is a formula worth carrying into the hall: the sale price of a unit is the applicable NAV, and nothing else. An investor handing over a sum buys units at NAV with nothing shaved off the top, and the distributor's commission is not deducted from it — it comes out of the scheme's expenses instead.

Exit load survives. It is charged as a percentage of NAV and subtracted from it, so the repurchase price is the applicable NAV reduced by the load. Two features of it are examinable in their own right. Regulation 44 caps what an open-ended scheme may charge, and it requires that any exit load collected be credited to the scheme rather than kept by the AMC. The money therefore stays with the investors who remained, which is the whole design: the load compensates the continuing unit holders for the cost of somebody else's early exit.

The distinction people lose is between NAV and price. Load does not change the NAV. NAV comes out of the portfolio; load is then applied to NAV to arrive at a transaction price for one investor. An exit load reduces what the exiting investor receives per unit, not the figure published that evening for everyone. Several situations are carved out of it altogether.

• Bonus units, and units allotted on reinvestment of IDCW, carry no exit load.
• A switch between the Regular Plan and the Direct Plan of the same scheme carries no exit load.
• No distinction may be made between unit holders on the size of their subscription, and parity applies at the portfolio level.
• Any imposition or increase in load applies to prospective investments only, never retrospectively.
• Goods and Services Tax on an exit load is paid out of the load itself; the scheme receives the load net of it.

Fair valuation, and who answers for the NAV

Valuation is not a matter of picking a convenient price. The Seventh Schedule to the 2026 Regulations sets out Principles of Fair Valuation, and the governing idea is realisable value: what a security could actually be sold for on the day, not what it cost and not the last price printed if that price has stopped meaning anything. The stated purpose is fair treatment between three people transacting on the same number — the investor who stays, the one buying in today, and the one redeeming today.

The mechanics are ordinary governance. The AMC's board approves a valuation policy, the policy is reviewed at least once a financial year and independently audited, and a new type of security cannot be bought until a methodology for valuing it has been approved. Where a security has no reliable market quotation, the policy is expected to say in advance what happens rather than be improvised on the day.

The clause worth remembering is the one about deviation. Responsibility for a true and fair NAV rests with the AMC irrespective of what its disclosed policy says. If following the policy would not produce fair value, the AMC is required to depart from it, document the reasoning, report it to the boards of both the trustee company and the AMC, and disclose it to investors. And where the Principles of Fair Valuation conflict with SEBI's detailed valuation guidelines, the Principles prevail. Having followed a disclosed procedure is not a defence for a wrong number.

Accounting and reporting behind the published number

All income and expenses accrued up to the date of valuation go into the NAV. Large and predictable items — management fees and other periodic expenses — accrue day by day. Minor items need not, but only so long as leaving them out does not move the NAV beyond the small tolerance the Master Circular allows. Changes in the portfolio and in units outstanding are to be recorded in the books by the next valuation date, with a short outer limit where the frequency of disclosure makes that impossible.

What happens when the tolerance is breached turns a bookkeeping rule into an investor protection, and the direction of the payment depends on who gained. Where investors were allotted units at a price above the true NAV, or were paid below it on redemption, the scheme pays them the difference. Where investors got the better end — a lower purchase price or a higher redemption price than the true NAV — the AMC pays the difference to the scheme, and may then recover it from those investors. Nobody is allowed to keep the benefit of the error.

Two smaller reporting points sit alongside. NAVs are rounded to four decimal places for index funds and debt-oriented schemes and to two places for the rest, which is why a liquid fund's NAV looks so much more precise than an equity fund's; a fund may publish more decimals if it discloses that it does. And regulation 68 requires an annual report for every scheme in the prescribed form, where the audited accounts behind the daily number finally appear.

What a scheme is allowed to distribute

Regulation 45 lets an AMC declare an Income Distribution cum Capital Withdrawal in line with the scheme's offer document. The name is deliberately ugly, and the ugliness is the lesson: part of what is paid out may be the investor's own capital coming back, and the offer document has to say so.

The constraint is accounting. IDCW may be paid only out of distributable surplus. When units are sold above face value, the part of the sale price not attributable to realised gains goes into the Unit Premium Reserve, which is treated on a par with unit capital and cannot be used to pay IDCW. When units are sold below face value, the shortfall is debited to distributable reserves, and no IDCW can be declared until those reserves turn positive again. The account statement must show income distribution and capital distribution separately, and the payout is due within seven working days of the record date.

For anyone doing the job, the practical point is the effect on NAV. A distribution comes out of the scheme's own assets, so the NAV falls by the amount distributed on the record date. An investor in the IDCW option and one in the Growth option of the same scheme hold the same value the moment afterwards; only the form differs. Selling an IDCW option as a scheme that pays a regular income is exactly where this goes wrong, and it is the mis-selling the renaming was meant to stop.

NAV, expenses and pricing in a segregated portfolio

When a debt or money market instrument held by a scheme suffers a credit event — a downgrade to below investment grade, a further downgrade below that, or an actual default on an unrated instrument — the AMC may carve it out into a segregated portfolio, leaving the rest as the main portfolio. Doing so is optional, requires an enabling provision in the scheme information document and trustee approval, and exists so that one bad issuer does not force the entire scheme to be transacted on the worst assumption.

The pricing rules run from the date of the credit event. Every existing investor is allotted the same number of units in the segregated portfolio as they hold in the main portfolio. An investor redeeming is paid on the NAV of the main portfolio and continues to hold the segregated units; an investor subscribing is allotted units in the main portfolio only. If the trustees do not approve the segregation, subscriptions and redemptions are processed on the NAV of the total portfolio instead. Segregating excuses nothing about valuation — the affected instrument is still valued on fair-value principles, with the credit event taken into account.

Expenses are handled separately and tightly. No investment and advisory fee may be charged on a segregated portfolio at all. Other expenses may be charged only when recovery actually happens, on a pro-rata basis, and are capped by the simple average of what the main portfolio was charged over the period the segregated portfolio existed. Legal costs of recovery may be charged in proportion to the amount recovered, within the same ceiling, and anything above it is borne by the AMC. In no case may the cost of a segregated portfolio be pushed onto the main portfolio.

• The NAV of the segregated portfolio is declared on every business day, alongside the main portfolio's.
• No subscription or redemption is allowed in the segregated portfolio, so its units are listed on a recognised stock exchange within ten business days to give unit holders a route out.
• A statement of holding showing the units held in the segregated portfolio, with the NAV of both portfolios as on the day of the credit event, goes to investors within five business days.
• Published scheme performance must reflect the fall in NAV caused by the segregation, disclosed as a footnote along with any recoveries.

What the examination tends to ask here

Questions in this unit reward precision about sequence and about who bears what. The computation is often tested as arithmetic, with an accrued expense or a current liability planted among the figures to see whether it gets subtracted before the division. The sale price against repurchase price distinction comes up because that is where the absence of an entry load actually bites, along with the standing trap that an exit load reduces the exiting investor's proceeds rather than the scheme's NAV. On expenses, the distinctions that matter are which costs sit inside the base limit and which sit outside it, who bears expenditure above the ceiling, and the fact that the ratio is already reflected in the published NAV rather than billed. The distributable-surplus material turns on a single idea — that a distribution is not new money — so it tends to be asked as what happens to NAV on the record date, or which reserve cannot fund a payout. Segregated-portfolio questions usually come down to which NAV a redemption is paid on and what may be charged to the carved-out portion. Where a slab, a cap or a threshold appears, check the current text of the regulation rather than trusting a remembered figure; those are revised from time to time, and it is the mechanism that is being examined.