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Decoding Those Mutual Fund Jargons and More!

In the world of investing, financial assets have seen a good traction over the past few years. Whether it is mutual funds or direct equity investment, the penetration has increased significantly. However, there are still a few who consider it as a complex field and hence avoid entering the world of financial assets investing. There are few reasons as well for the same.

Firstly, not everyone has got the time and capability to enter financial asset investing. A few stay away as they find the jargons involved a bit complicated to understand. In mutual funds investment also there are few jargons that are simple but look a bit complicated to laymen. Let us try to simplify these jargons used in basic concepts of mutual funds investing. Here we are going to understand the concept of net asset value (NAV), mark to market (MTM), dividend distribution tax (DDT) and securities transaction tax (STT).

What is a NAV?

The net asset value (NAV) of a mutual fund scheme is the market value of all securities held by the fund. It is also the performance of a mutual fund scheme. Mutual funds are pooled investments that are invested by fund managers in different asset classes. For instance, if the net assets are worth Rs. 100 crore and there are 1 crore units, the NAV would be Rs. 100.

The NAV of a mutual fund shows the market value of the fund’s assets after reducing the liabilities attributed to those investments. With regards to the change in NAV, as the value of the invested assets changes every day, the NAV also changes every day. As far as who calculates the NAV, the asset management company (AMC) itself calculates the NAV or it can be calculated by the securities and exchange and board of India (SEBI) authorised firm chosen by the AMC.

The net assets of a mutual fund include all the resources that have been invested into the stocks of the mutual fund scheme. The net asset calculation is done in the following way.

Market Value of the Investments - XXX

Add: Other Accrued Income - XXX

Other Assets - XXX

Less: Accrued Expense - XXX

Other Liabilities /Payables - XXX


Net Assets - XXX

Following are few of the common examples of net assets and regulations regarding their valuations

  1. Listed and traded securities should be valued on the closing market price or market value.

  2. Illiquid shares and debentures should be valued at the lower of the book value of the last traded (available) price.

  3. Listed and the traded debentures or bonds should be valued at the lower of either the closing value or the yield value.

  4. Fixed income securities should be valued at their current yields.

The next important question is how frequently the NAV is calculated. With efficient systems and processes the NAV of every fund is calculated at the end of every market day/trading day or a business day. As stated earlier, it is done on the basis of closing market price of the securities that the fund or a scheme is invested in.

Understand the Expense Ratio

AMCs manage the assets of mutual funds and take the investment decision to help the investors generate returns. AMCs make and charge different expenses. A few are listed below:

  1. Office rentals

  2. Employee salaries

  3. Legal and audit fees

  4. Software charges

  5. Distributor commissions, etc.

All above expenses are together termed as total expense ratio when calculated as percentage of total asset under management (AUM) of a scheme. Usually, the total expense ratio declines as the AUM increases. Regulator SEBI has placed limits to the maximum expense ratio that can be charged by the AMCs.

How to calculate the reserve for declaring dividends?

Investing in mutual funds is considered as one of the safest modes with a regulatory authority like SEBI present in there. And hence the guideline of the calculation of reserves is also a prescribed process from the regulators.

  1. All the profit earned (including accrual income) is available for distribution.

  2. Valuation gains are ignored but the valuation losses need to be adjusted against the profits.

  3. Mutual funds declare the dividends only when there is a surplus which can be distributed. They are a reflection of distribution of profits and gains.

For instance, an investor buys a fund at a NAV of Rs. 15. Here Rs. 10 would go into the capital account since the face value of the fund is Rs. 10. The balance of Rs. 5 will go as premium reserve. If the invested amount or NAV gains and moves above Rs. 15 – suppose Rs. 18, then the fund can declare a dividend of Rs. 3. (Rs. 18 - Rs. 15 = Rs. 3).

However, the AMC cannot use the unit premium reserve to pay dividends. In the above example, it cannot use Rs. 5 to pay dividends.

What is MTM and its importance?

MTM means marking it to the market. In mutual fund parlance, the process of valuing each security at its market price is called ‘Mark To Market’. It is very important to understand the process.

  1. MTM helps the investors in finding the asset values according to the market prices at the end of each day in order to arrive at the profit or loss status of the invested fraternity.

  2. MTM helps the investor buy or sell units of schemes at a true and most importantly fair price.

  3. Accessing a scheme or a fund manager’s performance is easier based on the MTM.

What was DDT and how has it changed now?

This is tax on dividends distributed by both equity and debt-oriented mutual funds schemes. Dividends refer to profits realised by companies which it shares with its equity shareholders. With the announcement of Budget 2020, a major change has been done on the tax liability on dividend income of the investor. When any mutual fund decides to distribute its profit to its shareholders, DDT is levied. Earlier, dividends were taxed at the source by the distributing company and the remaining amount was passed on to the investor.

As per the announcement, dividends would be taxed at the hands of the investor, as per the income tax slab of the investor. Dividend income would be included in the taxable income of the investor under the heading “income from other sources” and then taxed accordingly. The dividend plans of mutual funds made it mandatory for fund houses to declare dividends on the gains made by the schemes. This dividend was taxed at 11.64 per cent for equity funds, and around 29 per cent for debt funds. Now it will be taxed as per the tax bracket. If someone falls in the highest tax bracket, that person needs to pay around 30 per cent tax, plus surcharge and cess. This high tax rate will impede investors from opting for the dividend plan of mutual funds.

What is STT?

STT is a tax on the value of transactions in equity shares, derivatives, exchange traded funds (ETF’s) and equity mutual fund units. It is not applicable on the debt or debt-oriented mutual fund units. However, it is applicable when one switches out to a different mutual fund scheme.

A few rates of STT are as follows:

  1. Equity shares/mutual funds/ETF on buy and sell (delivery based transactions) it is 0.10 per cent.

  2. Equity shares/mutual funds/ETF on buy and sell (non-delivery based transactions) it is 0.025 per cent.

  3. Equity mutual fund purchase from AMC it is Nil.

  4. Equity, mutual funds and ETF sale (called as repurchase) by an AMC is charged at 0.001 per cent.

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