Part 1 of 3 in our portfolio valuation series: funds and AIFs, loans and advances, and corporate guarantees.

Key takeaways

• Category I and II AIFs must value their investments at least every six months through an independent valuer; this can be extended to one year only with approval of at least 75% of investors by value (Regulation 23, SEBI AIF Regulations, 2012).
• Reported NAV is a starting point for fair value, not always the answer: reporting lag, manager valuation policy and investor-level factors can all create gaps.
• Most of the effort lies in unlisted holdings, valued by triangulating the market, income and cost approaches, with calibration to a recent transaction.
• Share-class rights (OPM / PWERM), marketability (DLOM) and the distribution waterfall can move the value of an investor’s units materially.

Investors rarely invest directly into a single company. Increasingly, capital flows through pooled vehicles, such as mutual funds, Alternative Investment Funds (AIFs), private equity funds and fund-of-funds, that in turn hold a portfolio of underlying assets. For anyone responsible for AIF valuation in India, understanding how these vehicles are structured, and how their reported Net Asset Value (NAV) relates to fair value, is the starting point for the entire exercise. This first article covers funds and AIFs; the next two cover loans and advances, and corporate guarantees.

1. Fund vs. AIF: What Is the Difference?

The term “fund” is often used loosely, but in the Indian regulatory context it helps to be precise. A mutual fund is a SEBI-regulated, open- or close-ended vehicle that pools money from a large number of investors and invests in a defined universe of securities such as equities, bonds and money market instruments. It is highly regulated, offers daily or periodic liquidity, and computes NAV frequently, often daily.

An Alternative Investment Fund, on the other hand, is a privately pooled investment vehicle registered under the SEBI (Alternative Investment Funds) Regulations, 2012, that collects funds from sophisticated investors, whether Indian or foreign, for investing in accordance with a defined investment policy. AIFs are categorised into three types:

• Category I: Funds investing in start-ups, SMEs, infrastructure or other sectors considered socially or economically desirable (e.g., venture capital funds, infrastructure funds, social venture funds).
• Category II: Funds that do not fall under Category I or III and do not undertake leverage other than to meet day-to-day operational requirements (e.g., private equity funds, debt funds, real estate funds, fund-of-funds).
• Category III: Funds that employ diverse or complex trading strategies and may use leverage, including through investment in listed or unlisted derivatives (e.g., hedge funds, long-short funds).

The practical distinction that matters for valuation is this: mutual funds mostly hold liquid, exchange-traded instruments where market prices are readily observable, while AIFs, particularly Category I and II funds, typically hold unlisted, illiquid investments where fair value must be estimated rather than simply read off a screen. This makes AIF valuation a meaningfully harder problem, and it is the primary focus of this article.

2. AIF Structure and Investment Lifecycle

Most AIFs, and many offshore private equity and venture capital funds, are structured as closed-ended trusts or LLPs with a fixed tenure, commonly 7 to 10 years, extendable by 1 to 2 years at the discretion of the manager or investors. Investors commit capital upfront but contribute it in tranches as the manager calls it, a mechanism known as drawdown or capital call. Distributions flow back to investors as investments are realised, often net of a hurdle rate and carried interest payable to the manager.

The lifecycle typically unfolds in three broad phases:

• Investment period (Years 1 to 5): Capital is drawn down and deployed into portfolio companies or assets. NAV in this period is driven largely by cost, with markups or markdowns as follow-on rounds or performance data become available.

• Holding and value-creation period (Years 3 to 7): Portfolio companies mature; valuations increasingly diverge from cost and reflect operating performance, comparable transactions and market multiples.

• Exit and harvest period (Years 6 to 10): Investments are realised through IPOs, strategic sales or secondary transactions, and proceeds are distributed to investors, winding the fund down toward a terminal NAV of zero.

An investor’s own holding in the fund is best thought of as a claim on this evolving pool of underlying assets, net of the fund’s liabilities, management fees and any accrued but unpaid carried interest. Valuing that holding properly requires understanding both the mechanics of the fund vehicle and the fair value of what it holds underneath.

3. NAV vs Fair Value: Are They the Same Thing?

Net Asset Value is, by definition, the value of a fund’s assets minus its liabilities, usually expressed on a per-unit basis. In principle, if every underlying asset is marked to fair value and every liability is correctly stated, the fund’s reported NAV is fair value. In practice, three gaps commonly arise:

• Reporting lag: AIFs typically report NAV quarterly or semi-annually, whereas an investor may need a valuation as of a different date, requiring an estimate of value movement in the interim.

• Valuation policy differences: Not every fund manager marks unlisted holdings with the same rigour or frequency; some rely on cost or the last funding round for extended periods even where evidence suggests a change in value.

• Investor-level adjustments: The investor’s own stake may need adjustment for factors that do not appear in the fund’s own NAV statement, such as illiquidity of the fund interest itself, restrictions on transfer, or a secondary-market discount if a sale is contemplated.

For financial reporting purposes (for instance, under Ind AS 109 or IFRS 9), an investor holding units in a fund must generally value that holding at fair value through profit or loss, using the fund’s reported NAV as a starting point but applying professional judgement to adjust for the gaps above where they are material.

4. Regulatory Framework for AIF Valuation in India

The valuation of AIF investments is governed by Regulation 23 of the SEBI (Alternative Investment Funds) Regulations, 2012, and the related SEBI circulars and master circulars. The key requirements are:

• Category I and II AIFs: Valuation of investments at least once every six months through an independent valuer appointed by the AIF. This period may be extended to one year with the approval of at least 75% of the investors by value of their investment in the AIF.

• Category III AIFs: The calculation of NAV must be independent of the fund management function, and NAV must be disclosed to investors at intervals not longer than a quarter for close-ended funds and a month for open-ended funds. For the purpose of calculating NAV, Category III AIFs must also have their investments in unlisted securities and listed debt securities valued by an independent valuer.

• Valuation procedure: Every AIF must provide investors with a description of its valuation procedure and the methodology for valuing assets.

• Independent valuer: The manager must ensure the AIF appoints an independent valuer who satisfies the criteria specified by SEBI, and that the valuer carries out valuation in the manner SEBI specifies.

SEBI’s standardised valuation framework, introduced by its June 2023 circular (SEBI/HO/AFD/PoD/CIR/2023/97), requires securities for which norms are already prescribed (for example, under the Mutual Fund Regulations) to be valued accordingly. Investments not covered by specified norms are to be valued in line with valuation guidelines endorsed by an eligible AIF industry association, with the IPEV Guidelines being the endorsed framework for such investments. The IPEV Guidelines were updated in 2025 and place greater emphasis on calibration and its documentation at every measurement date. The manager remains responsible for ensuring the true and fair valuation of the investments of the AIF scheme.

More recently, SEBI’s circular of 6 February 2026 requires AIFs to report the latest NAV of their units to depositories, through their registrars and transfer agents, within the timelines it prescribes. This puts valuation dates, and the quality of the underlying valuation report, in front of a wider set of investors.

5. Valuing the Underlying Portfolio Investments

The heart of fund and AIF valuation lies in how the underlying investments are valued, since the fund’s NAV is only as reliable as the values assigned to what it holds. Approaches vary by the nature of the underlying investment, but common methodologies include the following.

5.1 Market Approach

Where the underlying company has undergone a recent, arm’s length financing round involving a new, sophisticated investor, the price of that round is often used as the starting point for fair value, adjusted for the time elapsed and any change in circumstances since the round closed. Where comparable listed companies exist, valuation multiples such as EV/EBITDA or Price/Book, drawn from a defined peer set, can be applied to the investee’s financial metrics, with an illiquidity discount applied to reflect the absence of a public market for the shares.

Two variants of the market approach are used side by side. The guideline transaction method anchors to actual deal prices, such as the recent funding round itself or comparable M&A transactions in the sector, while the guideline public company method starts from trading multiples of listed peers.

Because listed peers are usually larger, more liquid and better diversified than a private investee, the raw peer multiple is rarely applied as-is. It is first adjusted for differences in growth rate, margin profile and scale (a small, fast-growing investee may justify a premium to a mature peer set on a forward multiple, even after an illiquidity discount), and then applied to a normalised earnings or revenue base for the investee rather than a single unadjusted year. A control premium or minority discount is also considered depending on whether the fund’s stake carries board representation or other control rights, since listed peer multiples typically reflect minority, freely tradeable positions.

5.2 Income Approach (DCF)

For businesses with a reasonably predictable and forecastable cash flow profile, a discounted cash flow (DCF) analysis is used, discounting projected free cash flows to the firm or equity at a rate that reflects the risk of those cash flows. This approach is particularly relevant for infrastructure and yield-generating assets held by Category I infrastructure funds.

The discount rate is usually built up rather than picked off a shelf: a risk-free rate plus an equity risk premium and a beta-adjusted market risk premium give a base cost of equity, to which a size premium and a company-specific risk premium (reflecting factors such as customer concentration, key-person dependence or limited operating history) are added. Where a project or business also carries debt, this is blended into a weighted average cost of capital.

Terminal value, which often accounts for the majority of a DCF’s total value for a growth business, is estimated either through a Gordon growth formula (a stabilised long-run growth rate, rarely above nominal GDP growth) or an exit multiple benchmarked to comparable transactions, and the two should be cross-checked against each other. Because DCF output is sensitive to small changes in the discount rate and terminal growth assumption, valuers routinely present the resulting value as a range across a sensitivity grid rather than a single point estimate.

5.3 Cost / Replacement Approach

For very early-stage investments where neither a recent financing round nor a forecastable cash flow stream exists, cost may serve as a reasonable proxy for fair value in the near term, though this should be revisited as soon as fresh evidence of value emerges, such as a subsequent round, a change in the regulatory environment or a shift in the investee’s operating trajectory.

A common refinement, particularly for early-stage venture holdings, is milestone-based valuation: rather than holding an investment at cost until the next priced round, cost is adjusted upward or downward in defined increments as the investee clears (or misses) specific, pre-agreed milestones such as regulatory approval, a product launch or a revenue threshold, with each milestone assigned an indicative valuation impact at the time of investment. This gives a more graduated, evidence-linked progression of value between funding rounds than a binary held-at-cost-until-the-next-round approach.

6. Valuing Unlisted Investments: The Core Challenge

The majority of the valuation effort in AIF and PE fund portfolios is spent on unlisted investments, precisely because there is no continuously observable market price to anchor to. Valuers typically triangulate across multiple methods, for example cross-checking a DCF-derived value against a comparable-companies multiple and the price of the most recent funding round, to arrive at a defensible fair value range rather than relying on a single number from a single method.

Key judgement areas that recur across unlisted investment valuations include the selection of an appropriate discount rate or cost of equity, the choice and adjustment of comparable companies given differences in scale and growth, the treatment of any preferential rights (such as liquidation preferences or anti-dilution protection) attaching to the specific class of shares held by the fund, and the application of a discount for lack of marketability given the absence of an active secondary market.

6.1 Calibration and the Backsolve Method

A widely used technique, particularly favoured under the IPEV Guidelines, is calibration: using the price of a recent, arm’s length transaction (typically the most recent funding round) as an anchor, and then “backsolving” the assumptions of an option-pricing or discounted cash flow model so that it reproduces that observed price at the transaction date. Once calibrated, the same model, holding methodology consistent, is rolled forward to the valuation date using updated inputs, such as revised financial performance, a changed peer group or elapsed time to a milestone, to estimate how value has moved since the round. This anchors the valuation in real transaction evidence while still allowing it to evolve as circumstances change, rather than freezing value at the last round price indefinitely.

What gets backsolved depends on the model: in an option-pricing framework it is typically the implied volatility of the underlying business (since the strike prices and waterfall are fixed by the round’s term sheet), while in a DCF-based calibration it is more often the discount rate or an implicit growth assumption. Whichever parameter is solved for, the same model structure and the same solved parameter should be carried forward consistently at each subsequent valuation date. Switching methodology or re-solving the calibrated parameter every quarter defeats the purpose of anchoring to a real transaction and makes period-on-period movements hard to explain.

6.2 Discount for Lack of Marketability (DLOM)

Because units or shares held by an AIF in an unlisted company cannot be sold quickly or without cost, a discount for lack of marketability is commonly applied to a value that has otherwise been derived using listed-company multiples or comparable transaction evidence. DLOM is typically estimated using option-based models (which price the cost of foregoing the ability to sell during a restriction period), restricted stock studies or pre-IPO discount studies, and commonly ranges from 10% to 30% depending on the expected time to liquidity, the volatility of the underlying business and the specific rights attached to the shares held.

The two option-based models most commonly seen in practice work differently. The Chaffe (protective put) model prices the cost of buying downside insurance against a price decline during the restriction period. The Finnerty (average strike put) model recognises that a holder selling into an illiquid position typically realises something closer to the average price over the holding period rather than the price on a single exit date, which usually produces a somewhat lower discount than Chaffe for the same inputs.

Restricted stock and pre-IPO studies, by contrast, are empirical rather than model-based: they look at actual historical discounts at which similar restricted or pre-IPO shares traded relative to their later freely tradeable price. Longer expected holding periods and higher underlying volatility both push the discount toward the upper end of the range, while a shorter, more certain path to liquidity (for example, a company already in late-stage IPO preparation) supports a discount at the lower end.

6.3 OPM vs PWERM: Valuing Complex Capital Structures

Where an investee company has raised several rounds of funding, each potentially carrying different preference rights, conversion ratios or anti-dilution protections, the fund’s specific class of shares may not be entitled to a simple pro-rata share of total equity value. In such cases, an Option Pricing Method (OPM) or a Probability-Weighted Expected Return Method (PWERM) is used to allocate the company’s total equity value across the different share classes based on their specific economic rights, rather than assuming every shareholder participates in value pro-rata.

The two methods suit different situations. OPM treats each class of shares as a call option on the total equity value with a strike price set by the liquidation preferences and conversion terms. It is generally preferred when a liquidity event is still some way off and its form (IPO, sale or continued private ownership) is genuinely uncertain, since it does not require the valuer to assign explicit probabilities to specific exit scenarios.

PWERM instead assigns explicit probabilities to a small number of defined future scenarios, for instance a 40% chance of an IPO in two years, a 35% chance of a strategic sale and a 25% chance of continued private operation. It values the fund’s specific share class under each scenario and probability-weights the results, and it tends to be more suitable closer to an anticipated exit, when management and the fund have a clearer view of the realistic paths forward and their relative likelihood.

7. Valuation Across Different Asset Classes

The table below summarises how the primary approach typically varies with the type of underlying asset and the AIF category that usually holds it.

The specific inputs that drive the valuation differ meaningfully across these categories:

• Early-stage equity: the terms of the most recent round (price, preference structure) and the status of pre-agreed milestones.

• Growth-stage equity: the discount rate, the selected peer multiple and the size of the DLOM.

• Infrastructure and real estate: the contracted or projected cash flows, the discount rate applied to those cash flows, and any regulatory asset base or capitalisation rate.

• Private debt: the credit spread applied over the base rate and any expected loss adjustment for credit deterioration since origination.

8. Valuation Challenges Specific to Funds and AIFs

• Information asymmetry: The valuer often relies on financial and operational information provided by the fund manager or the investee company, which may lag actual performance.

• Absence of an active market: By design, most AIF holdings are illiquid, so every valuation method involves some degree of estimation and judgement.

• Layered structures: Fund-of-funds and feeder-master structures add an additional layer of valuation, since the feeder’s NAV depends on the master fund’s own (often equally judgement-heavy) valuation.

• Waterfall and carried interest mechanics: Determining the fair value of an investor’s specific unit class may require modelling the fund’s distribution waterfall, since carried interest and hurdle provisions can cause per-unit value to diverge across share classes.

• Timing mismatches: Portfolio companies may have different financial year-ends or reporting cadences than the fund itself, requiring interpolation or roll-forward adjustments.

How the Distribution Waterfall Affects NAV

In practice, modelling the waterfall means projecting how a rupee of exit proceeds would actually be split at the valuation date: return of capital and any preferred return (commonly 8% per annum) to investors first, then a catch-up to the manager, and finally an agreed profit split (typically 80/20) on remaining gains.

The waterfall can be modelled on either a deal-by-deal (“American”) basis, where carry can crystallise on early exits, or a whole-of-fund (“European”) basis, where all capital and preferred return must be returned before any carry is paid. The choice affects both the amount of carried interest accrued at a given valuation date and how much of it should be treated as a liability that reduces the investor’s per-unit NAV.

9. Governance: Process, Frequency and Documentation

A defensible fund or AIF valuation is as much a function of a disciplined process as it is of technical methodology. Well-run fund managers and independent valuers typically institute the following governance practices:

• A board- or trustee-approved valuation policy, set at fund inception, that specifies the methodology to be applied to each category of investment, the frequency of valuation, and the circumstances that would trigger an off-cycle revaluation (such as a material adverse event at a portfolio company).

• A valuation committee, independent of the deal team that sourced and negotiated the investment, to review and challenge proposed valuations before they are finalised, separating the incentive to show strong performance from the responsibility to report fairly.

• An independent valuer meeting SEBI’s criteria. Category I and II AIFs must have their investments valued by an independent valuer at least every six months, or annually where at least 75% of investors by value approve. Interim valuations prepared internally between these dates still benefit from an external check on the manager’s own judgement.

• Contemporaneous documentation of the key assumptions, data sources and judgement calls underlying each valuation, so that the basis for a markup or markdown can be reconstructed and defended well after the fact, including to auditors, regulators or investors.

• Sensitivity disclosure, particularly for Level 3 fair value investments (those valued using significant unobservable inputs under the Ind AS 113 / IFRS 13 fair value hierarchy), showing how the reported value would change under reasonably possible alternative assumptions for the most significant unobservable inputs, such as the discount rate or the selected multiple.

10. Practical Examples

Example 1: Valuing an Investor’s Stake in a Category II AIF

Illustrative case

An investor holds a 4% interest in a Category II AIF that has called down 70% of its committed capital and invested in six portfolio companies. The fund’s most recent quarterly NAV statement, dated three months prior to the valuation date, values the portfolio at ₹250 crore against total commitments of ₹300 crore.

Step 1, roll forward NAV: Two of the six portfolio companies completed follow-on funding rounds since the last NAV statement, at valuations 15% and 22% higher than their carrying values. These markups are reflected first, updating the reported NAV for known, subsequent events.

Step 2, re-test unchanged holdings: For portfolio companies with no new round, a DCF and comparable-multiple cross-check is performed to confirm no material change in fair value is warranted.

Step 3, adjust for fund-level liabilities: Accrued but unpaid management fees and an estimate of crystallising carried interest (given the fund is now realising gains) are deducted.

Step 4, apply investor-level factors: Since the investor’s fund interest cannot be freely transferred without General Partner consent, a marketability discount is considered when the valuation is prepared for a potential secondary sale (though typically not for financial reporting NAV).

Result: an updated, investor-specific fair value of the 4% stake that reflects both the portfolio’s most recent evidence of value and the fund’s own liability structure, rather than a mechanical roll-forward of the last reported NAV.

Example 2: Calibration for an Early-Stage Venture Investment

Illustrative case

A Category I venture capital fund invested ₹5 crore in a Series A round of a technology start-up 18 months ago, acquiring Series A preference shares at a post-money valuation of ₹60 crore. Since then, the company has not raised further capital, but has grown revenue by 80% and achieved a key product milestone specified at the time of investment.

Step 1, calibrate at inception: An option-pricing model is built and calibrated so that, using the Series A round terms and the company’s financials at that date, it reproduces the ₹60 crore post-money price, confirming the model’s implied volatility and discount rate assumptions are reasonable.

Step 2, update fundamentals: Revenue and other operating inputs are updated to reflect current performance, and the achieved milestone is reflected by removing the probability discount that had been applied to that milestone at the initial calibration date.

Step 3, re-run the model: Holding the calibrated volatility and risk parameters constant, the model is re-run with updated inputs, producing a higher implied enterprise and equity value consistent with the company’s improved performance.

Step 4, allocate to the specific share class: An OPM allocation is performed across the ordinary and Series A preference shares, reflecting the preference shares’ liquidation preference, to determine the value attributable to the fund’s holding rather than to equity as a whole.

Step 5, apply DLOM: A marketability discount of approximately 20%, reflecting the company’s early stage and the absence of any near-term liquidity event, is applied to the resulting per-share value.

Result: a calibrated, evidence-based markup that is materially more defensible than either leaving the investment at the original ₹5 crore cost indefinitely, or applying an arbitrary uplift disconnected from a documented model.

Frequently Asked Questions on AIF Valuation

How often must an AIF be valued in India?

Category I and II AIFs must value their investments at least once every six months through an independent valuer; this can be extended to one year with the approval of at least 75% of investors by value. Category III AIFs must ensure NAV is calculated independently of fund management and disclosed at least quarterly (close-ended) or monthly (open-ended).

Who can act as an independent valuer for an AIF?

The valuer is appointed by the AIF and must satisfy the criteria specified by SEBI from time to time. The manager and its key management personnel remain responsible for ensuring the valuation is carried out in the manner SEBI specifies.

Is NAV the same as fair value for an AIF unit?

Not necessarily. Reported NAV is a starting point, but reporting lag, differences in manager valuation policy and investor-level factors such as transfer restrictions can mean the fair value of an investor’s stake differs from the reported NAV.

Which valuation methods are used for unlisted AIF investments?

The market, income and cost approaches, typically triangulated and calibrated to the most recent arm’s length transaction. Share-class rights are allocated using OPM or PWERM, and a discount for lack of marketability is applied where appropriate.

What is a typical DLOM range for unlisted investments?

DLOM commonly ranges from 10% to 30%, depending on the expected time to liquidity, the volatility of the underlying business and the rights attached to the shares. It is estimated using models such as Chaffe and Finnerty or from empirical restricted stock and pre-IPO studies.

Conclusion

A reliable AIF valuation does not stop at the NAV on a statement. It starts there, then tests the fund’s underlying marks, adjusts for liabilities, share-class rights and marketability, and documents every judgement in a way that auditors, regulators and investors can follow. Parts 2 and 3 of this series extend the same discipline to loans and advances and to corporate guarantees.