VALUATION AND

PERFORMANCE EVALUATION
OF MUTUAL FUNDS

Submitted by: -
Sushil Kumar (85)
NEED OF VALUATION METHOD
 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
PRACTICES
As 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 and
a) Prescribes detailed valuation methodologies in its fund regulations,
b) Mandates disclosure of valuation methods used for information of investors
 BASIC VALUATION PRINCIPLE
 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 company’s 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.

VALUATION OF DEBT SECURITIES
 Traded securities.

 Thinly-Traded securities.

 Valuation of non-Traded/thinly-traded debt

securities.
VALUATION OF TRADED
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.
VALUATION OF THINLY-TRADED
SECURITIES
 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,
(A):- MONEY MARKET SECURITIES AND DEBT
SECURITIES UPTO 182 DAYS TO MATURITIES.
 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.
(B):-NON TRADED, NON GOVERNMENT, DEBT
INSTRUMENTS OVER 182 DAYS TO MATURES.
 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.

STEP:-B
 The difference between the two yields is the ‘spread’ over
the benchmark yield.
STEP:-C
 Yield so used for valuation adjusted to reflect the ‘illiquidity
risk’ of a security.

STEP:-D
 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.
CONVERTIBLE DEBENTURES AND
BONDS:
 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 non-
tradability 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.
2.SECURITIES WITH PUT OPTION:
 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.
VALUATION AND DISCLOSURE OF ILLIQUID
SECURITIES
 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.
VALUATION OF GOVT. SECURITIES
 Govt. securities are valued at the prices related
by the agency suggested by AMFI, currently only
CRISIL.
Measuring mutual fund performance
 MEASURE FUND PERFORMANCE

 The investors perspective

 Investors 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 perspective

 Advisers 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.
 PERFORMANCE MEASURES
 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.
 PERFORMANCE MEASURES
 Total Return
Total 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.
 PERFORMANCE MEASURES
 Return on investment or Total return with dividends reinvested
at NAV -:
A. The most suitable measures
The appropriate measure of the growth of an investor’s 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., Children’s
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 year’s,
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.
THE EXPENSE RATIO
 Purpose: It indicates fund’s efficiency and cost
effectiveness.

 Formula: Total Expense/Average of Net Asset.

 Suitability: Important in bond or debt funds.

 Limitation: It doesn’t hold good in case of funds with

small corpus.
THE INCOME RATIO
 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.
PORTFOLIO TURNOVER RATE
 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.
TRANSACTION COST
 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 fund’s 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.
EVALUATING MUTUAL FUND
PERFORMANCE
IMPORTANCE OF BENCHMARKING

 A fund’s 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 fund’s performance.

 It is very important to select the right benchmark to

evaluate a fund’s 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 fund’s 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
MARKET
1. 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 Fund’s 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 fund’s 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, Si-
bex, 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 NSE’s G-SEC and T-Bills
indices are used.
4. Appropriate Benchmarks – SEBI Disclosure
Requirement

SEBI requires MF to specify appropriate benchmarks

for each scheme in the Offer Document and Key
Information Memorandum.
BENCHMARKING RELATIVE TO THE
OTHER SIMILAR MUTUAL FUNDS

Apart from market based comparisons, it is important to

measure a fund’s 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.
BENCHMARKING RELATIVE TO OTHER
INVESTMENT OPTIONS OR FINANCIAL
PRODUCTS

 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 AGENCIES

Now 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.

2. 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.

EVALUATING THE FUND MANAGER / AMC

 The investor must evaluate the fund manager’s 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.
THANK YOU