Mark-to-Market & Fair Valuation Principles
Definition
Mark-to-Market (MTM) is the accounting practice of valuing securities held by a mutual fund at their current market price rather than their purchase price (historical cost). SEBI mandates that all mutual fund holdings must be valued at fair market value at the end of each business day to ensure the NAV accurately reflects the true worth of the portfolio. For equity securities, this means using the closing price on the stock exchange. For debt securities, valuation is done using matrices provided by agencies like AMFI and CRISIL. For illiquid or thinly traded securities, the AMC's valuation committee determines a fair value.
In Simple Words
Consider a practical scenario. Suppose a mutual fund bought 10,000 shares of Infosys at ₹1,400 three months ago. Today, Infosys is trading at ₹1,650. Should the fund show the Infosys holding at the purchase price (₹1.40 crores) or current market price (₹1.65 crores)? The answer is clear — SEBI requires current market price. This is mark-to-market. Why does this matter? Because an investor redeeming today should get the fair value of the fund, not a historical cost that may be outdated. MTM ensures that NAV accurately reflects reality every single day. For equity, the process is straightforward — the closing price from NSE/BSE is used. But debt valuation is more complex. Government bonds, corporate bonds, and money market instruments do not trade actively on exchanges like stocks do. For these, AMFI and CRISIL publish daily valuation matrices that fund houses must use. If a corporate bond is downgraded from AAA to AA, its valuation drops immediately, and this impacts the fund's NAV the same day. This is where events like the IL&FS crisis (2018) and Franklin Templeton crisis (2020) hit investors hard — debt securities that were valued at par suddenly had to be marked down because the issuers could not repay. Side-pocketing was introduced by SEBI in 2018 precisely for such situations — this is covered in a later section.
Real-Life Scenario
Consider the Aditya Birla Sun Life Medium Term Plan in September 2018. The fund held ₹300 crores worth of IL&FS bonds rated AAA. When IL&FS defaulted, the rating agencies downgraded the bonds to D (default). Under MTM rules, the fund had to immediately mark down the value of these bonds — in some cases to as low as 25% of face value. This meant the fund's NAV dropped sharply overnight, and investors who redeemed the next day received a much lower value. Priya, a 55-year-old retired teacher from Lucknow, had invested ₹20 lakhs in this fund for "safe" income. Her investment value dropped to ₹17.5 lakhs in a week because the debt securities in the portfolio were marked to their new (lower) market value. This is MTM in action — it protects current investors from redeeming at an inflated NAV, but it also means NAV can drop sharply when credit events occur.
Key Points to Remember
Frequently Asked Questions
Test Your Knowledge
3 questions to check your understanding
Under SEBI regulations, equity securities held by a mutual fund must be valued at:
Summary Notes
Mark-to-Market (MTM) means valuing portfolio securities at their current market price daily, not at historical cost — SEBI mandates this to ensure NAV accuracy
Equity is valued at exchange closing prices; debt is valued using AMFI/CRISIL matrices; illiquid securities are valued by the AMC's valuation committee
MTM ensures fairness to entering and exiting investors by reflecting real-time portfolio values in the NAV
Credit events (rating downgrades, defaults) must be reflected immediately in NAV under MTM rules — as seen in the IL&FS and Franklin Templeton episodes
Side-pocketing (introduced December 2018) allows segregation of impaired debt securities from the main portfolio to protect remaining investors
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Frequently asked questions
Does a fund with ₹10 NAV mean it is a new fund and therefore risky?
Not necessarily. A NAV of ₹10 usually indicates the fund is in its NFO stage or recently launched. However, NAV alone does not indicate risk — the risk depends on the underlying portfolio (equity, debt, hybrid), the fund manager's strategy, and market conditions. Always evaluate the scheme information document (SID), portfolio composition, and fund house track record before investing.
Why does NAV change every day?
NAV changes daily because the market value of the securities held by the fund changes every trading day. Equity prices fluctuate based on market forces, debt securities are revalued based on yield movements, and accrued income and expenses change. Since SEBI requires end-of-day NAV calculation, these changes are reflected in the updated NAV published after market hours.
Can NAV of a mutual fund go below zero?
No, NAV cannot go below zero. Since mutual funds invest in regulated securities traded on exchanges, even in extreme market crashes, asset values do not go to zero (unlike individual stocks of bankrupt companies). The lowest theoretical NAV would be close to zero if all holdings became worthless, but this has never happened in the history of Indian mutual funds.
Is NAV the same as the market price of an ETF?
No. For regular mutual funds, investors transact at NAV. But for ETFs (Exchange Traded Funds), there are two prices: the NAV (calculated end-of-day based on holdings) and the market price (the price at which ETF units trade on the exchange during market hours). The market price can be at a premium or discount to NAV depending on demand and supply.
When an investor receives dividends, does the NAV change?
Yes. When a mutual fund declares and pays a dividend (now called IDCW — Income Distribution cum Capital Withdrawal), the NAV drops by the dividend amount on the ex-dividend date. For example, if NAV is ₹50 and the fund declares ₹3 per unit as IDCW, the NAV will drop to approximately ₹47 on the record date. This is not a loss — the investor receives the ₹3 separately.
What happens if a security is not traded on a given day — how is it valued?
If an equity security is not traded on a particular day, it is valued at the last available closing price on the exchange. If it has not traded for more than 30 days, it is classified as a non-traded/thinly traded security and must be valued using fair valuation methods approved by the AMC's valuation committee. For debt securities, AMFI/CRISIL matrices provide daily valuations regardless of whether the security traded that day.
Why did SEBI introduce mark-to-market for debt funds?
Before MTM norms, some debt funds were valuing securities at "amortized cost" — essentially showing a smooth, straight-line return regardless of market conditions. This masked the true risk. When a credit event occurred (like IL&FS default in 2018), the sudden shift to market-based valuation caused sharp NAV drops. SEBI mandated MTM to ensure daily NAV transparency and prevent funds from hiding losses until a crisis erupted.
Does MTM apply to liquid funds as well?
Yes. From October 2019, SEBI mandated that liquid funds must value all securities with maturity above 30 days using MTM valuation. Earlier, liquid funds used amortization for securities up to 60 days maturity, which masked short-term volatility. Now, even liquid fund NAVs can show minor daily fluctuations due to MTM.
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