If you're like most mutual fund investors, you check the progress of your investments once or twice a week in the business pages. You head straight for the NAV column and quickly calculate how much your net worth has risen or fallen since you last checked. But investors in open-ended mutual funds are mistaken if they believe that all funds' NAV listings are just as reliable as closing prices on the National Stock Exchange.The fact is that the determination of a fund's net asset value can be much more subjective and malleable than most investors know. What you see may not be what you actually own.
The soundness of a fund's NAV depends on a couple of things: the method used by fund management to price lesser-known securities and the ease with which those securities can be sold, or liquidity. Few investors realise how much leeway a fund's management has when it comes to valuing lesser-known securities. Similarly, few realise how large a role liquidity plays in their fund's valuation.
With thinly tradedsecurities, there's no telling what price a fund manager's sell order will fetch if he taps the market in that security. An illiquid security, if sold, could very likely trade at a price much lower than its value in the disclosure. Daily unit prices of open-ended funds are determined, in most instances, by the value of the funds' holdings at the close of a day's trading.
Net asset value is calculated by adding the value of all the securities held in a fund, including cash and other assets, subtracting liabilities, and dividing the remainder by the number of units outstanding. Since these are the prices used for unit purchases and redemptions, mutual fund managers take great pains to assure they are statistically correct. Each security that trades daily on the National Stock / Mumbai Stock Exchange and is held by a fund is valued at the last traded price. Those are the easy ones.
Securities that don't trade during the course of a business day are trickier; they're valued at the last quoted price or at afair value determined in good faith by the trustees. Less liquid securities are the toughest of all. These are valued at a fair value determined in good faith by the board of trustees.
Should you be worried that your fund's net asset value may be subject to interpretation by management? Not if you own a fund that trades shares of big, public companies or highly liquid securities. But investors in several other types of funds, specially the funds with a major exposure in small illiquid stocks and most of the income funds should be aware that their holdings' values may not be all that they see. Most of the income funds are heavily into privately placed debts, a by product of our illiquid debt market.
This point is worth making now, given the volatile interest rates scenario which has emerged over the past year and which is here to stay. With most of the money flowing into the income funds today, the worry is that few income fund investors realise to what extent their funds may hold securities that are notexceedingly liquid. The problem is compounded in the case of open-end income funds, where the fund manager is forced to sell his liquid holdings in the event of heavy redemptions.
The January hike in the interest rates brought the problem of valuation to the fore with the NAVs of income funds showing divergent trends. Subsequently to have a common set of norms for all funds, AMFI has formed a technical committee. The committee wants the funds to follow model for evaluating unquoted securities developed by one rating agency of the other. It is to be seen if common valuation practices are actually implemented, as various models have their grey areas. Like in India, in most developed markets the responsibility of determining the fair value of unquoted securities rest with the trustees who have to be act in the best interest of the investors and not the AMC. Of course, in India the trustees are just figure heads. The lack of compulsory market-making only compounds the problem of illiquidity.
Unless SEBI takesa view on the responsibilities and accountability of the trustee or till we have a very liquid and developed debt market, the income fund investor can just hope that his mutual fund acts in his best interest.
-- Value Research
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
