AMFI Guidelines: This Is How Fund-Houses Will Cut Value Of Sub-Investment Grade Debt

Amid the Indian fund industry undergoing a tumultuous period due to the troubles in fixed income investments, mutual fund industry body AMFI has come out with guidelines on how mutual fund schemes should lower the value of sub-investment grade securities i.e. those securities that are below investment grade. Lowering the value of an investment is known as a haircut in the financial world. A haircut leads to the lower-than-market value placed on an asset, impacting the value of your investments in a fund.

As per an AMFI document viewed by RupeeIQ, the industry body has made it amply crystal clear in terms of how fund-houses should value such sub-investment grade debt. Readers of this website know how different fund-houses had virtually adopted different styles when it came to valuing debt securities, especially when they have been given poor ratings by external agencies.

While a haircut will obviously impact the Net Asset Value (NAV) of the fund, such clear guidelines help investors also understand how their fund will going forward react when portfolio security gets downgraded. This move brings clarity, certainty and brings back some sense of trust in how debt mutual funds operated. Back to back investment mistakes in IL&FS, some housing loan firms, Zee/Essel group and very recently Anil Ambani Reliance group companies have cast a dark shadow over the debt MF part of the Indian fund industry.

The haircut is expressed as a percentage. AMFI has come out with standard haircut for senior, secured securities. For such debt securities in infrastructure, real estate, loan against shares (LAS) and hospital, the industry body has directed fund houses to take a haircut of 15% when rating falls to ‘BB’. The haircut should be 25% when the rating is ‘B’. The haircut should be 35% when rating is ‘C’ and the quantum of haircut should be 50% when the rating is ‘D’. D rating stands for default grade.

The haircut amounts rise when such securities belong to other manufacturing and financial institutions. ‘BB’ rating means 20% haircut, ‘B’ rating means 40%, ‘C’ rating means 55% and ‘D’ rating means 75%. The haircuts are most aggressive for securities belonging to riskiest sectors like trading, gem & jewellery etc. Here, ‘BB’ rating means 25% haircut, ‘B’ rating means 50%, ‘C’ rating means 70% and ‘D’ rating means 100% i.e. virtually the whole value being written off.

Look at the table below to understand the haircuts.

AMFI write down

Additional read: From May 9, No Exit Load For Switching From ‘Regular Plan’ To ‘Direct Plan’ In Franklin MF Schemes; Will Others Follow Suit?

Subordinated or unsecured securities

For subordinated and unsecured (or both) securities, AMFI’s norms are stricter. This is understandable because the debt is not covered by any collateral. So, any rating downgrade has to be taken much seriously. As per AMFI, the haircuts in case of the three buckets – infra, real estate, hotels, LAS and hospitals; other manufacturing and financial instituitions; trading, gems, jewellery & others – is identical the moment the rating starts falling. For all the three buckets, a BB rating means 25% haircut, a B rating means 50% haircut, a C rating means 70% haircut and a D rating means 100% haircut

Look at the table below to understand the haircuts.

AMFI haircut unsecured debt

We sincerely hope that the fund industry will now act in a disciplined manner in terms of rating problematic debt securities, secured or unsecured. There have been some fund houses that have taken arbitrary decisions in valuing such debt. It is important for the fund houses to instill a renewed sense of trust among debt MF investors, who have been at the receiving end. Mutual funds, due to their pass-through structure, ultimately impact the investor money with any move.