Non-investment grade debt securities are those that have a credit rating below BBB. These instruments have a greater risk of default.
Mutual funds have to follow the norms laid down by the Securities and Exchange Board of India to value securities to ensure uniformity across all schemes for the calculation of the net asset value. Instruments with a credit rating below BBB will be valued at a price provided by designated valuation agencies. In the period that the valuation agency takes to provide the price, the mutual fund may value the instrument by applying indicative haircuts. The Association of Mutual Funds of India has set out best practices for applying haircuts for downgraded securities based upon the level to which the instrument has been downgraded, the sector to which the issuer belongs and whether the instrument is secured or not.
For instruments downgraded to default status, the haircut could be 50-100% of the value. Funds can take a more conservative valuation if they feel it’s warranted.