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 Because an investor redeeming today should get the fair value of the fund, not a historical cost that may be outdated.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