Mark-to-market valuation likely for all debt securities

Investors in mutual fund debt plans, especially liquid schemes, may have to brace for more uncertainty with regard to returns as the Securities and Exchange Board of India (Sebi) may make it mandatory for these debt products to assign the latest market price to all their bond investments from April 1.

Currently, only debt papers with a maturity of over 30 days need to be valued on a mark-to market basis. Most fund houses value the rest of the papers based on amortisation.

The shift is being undertaken to ensure the net asset value (NAV) of the fixed income schemes reflect the portfolio’s fair value. All categories of debt MFs including liquid funds and ultra short-term funds, which predominantly invest in debt papers with maturity below 30 days, will be impacted by the new method of calculation.


“Valuation of debt and money market instruments based on amortisation shall be dispensed with and shall completely shift to mark-to-market valuation with effect from April 1, 2020,” said minutes of the Sebi board meeting held on August 21. The move is aimed at boosting transparency in bond funds and aligning their values to the market prices.

For investors in fixed income schemes, this change in valuation method would mean NAV would fluctuate more frequently as prices could swing in the event of uncertain markets or changes in credit ratings.

Capturing market risks

The move could dim the popularity of products such as liquid schemes, where investors usually park their idle money. The assets managed by the liquid category of mutual funds was Rs 5.49 lakh crore as on August 31. Ultra short-term schemes managed money worth Rs 90,293 crore.

“Until now, in the case of securities with maturity less than 30 days, interest used to be amortised over the remaining period,” said a fund manager with a domestic mutual fund. “But now every day prices are released by the rating agencies. Those prices will be used for valuing securities and calculating NAV.”

Daily bond prices in India are provided by credit rating agencies in the absence of an active corporate debt market. The NAV of an equity fund is calculated daily based on the closing price of the shares. MFs use amortisation method to determine the daily price of the bonds.

Consider a mutual fund which has invested Rs 100 crore in debt papers of a company ‘A’ with a coupon rate of 10% and the tenure of the bond is 30 days. Since the fair market price of these bonds isn’t available, the fund house would divide the total interest receivable during maturity with the tenure of the bond, i.e. in this case 0.33%, and then accrue it daily. Hence, the value of the bond would be Rs 100.33 crore on the 30th day, Rs 100.66 crore on the 29th, Rs 100.99 on 28th and so on.

“In the event of a credit deterioration, a fund should mark down the value of security to reflect its true picture. In the current scenario that does not happen till the security defaults,” said the fund manager of another domestic fund house.

The current methodology doesn’t capture the real market risks. For instance, consider if the bonds of ‘A’ have been downgraded from AAA to say B+. In the current method, the NAV of the funds which have exposure to this paper will not be able to capture the impact of the downgrade in the NAV. Instead, they would add the interest for NAV calculation. However, in the mark-to-market valuation method, the downgrade will be captured in the price calculation and hence NAVs of the funds having exposure to ‘A’ will take a hit. Until last year, only debt papers with maturity of over 60 days were required to value the investments on a mark-to-market basis.