While evaluating the performance of a mutual fund, it is not enough to look at its performance in the immediate past. Funds need to be studied not just in individual contexts or in comparison with similar funds but also in the larger context of the economy and performance of the industry. An average investor may not be able to determine the long-term quality of the fund because they would not have the expertise to judge the fund on various financial performance parameters. This is where the concept of average credit quality comes in.
Average credit quality is a measure of the quality of a mutual fund, which can help investors decide whether they should invest in that fund. The average credit quality of a fund is given by various rating companies. At present, the Securities and Exchange Board of India (SEBI) recognises 7 ratings companies in the country.
Each rating company has a distinctive method of calculating the credit quality of a mutual fund. Usually, it is calculated as the average rating of individual bonds held by the fund relative to the size of the portfolio. Usually rating agencies provide ratings like AAA and BBB, with AAA indicating high credit quality, which is ideally suited for conservative investors. Each rating company measures a variety of parameters, using a unique methodology, so that an investor can be better informed about the fund he/she is investing in. Funds marked D are usually seen as those either already in default or to default in the near future.
The credit rating companies give out ratings after analysing the asset management company’s entire portfolio, its public filings, internal documents, past performance, decision-making processes and any industry-specific surveys or reports. A good credit rating company also speaks to the asset management companies regularly to get periodic feedback on how funds are performing. The rating firm also parses through all this data in the context of the larger economic trends in the country.
The alphabetical rating gives the investor an idea as to what risk would be involved in the investment from high to medium to low. Highly rated funds are called investment-grade funds and are the safest to bet on. The yields in these may be lower on average, but they are associated with lower risk of loss to the investor. The non-investment grade funds, on the other hand, give higher yields but also carry higher risks.
With the help of an average credit rating investors can have a clearer picture before taking a decision. They can use this to compare funds, based on their specific requirements, liquidity needs and risk taking appetite.
Average credit quality ratings also help the fund management companies in making decisions regarding the portfolios they are offering and how to mix and match it to the requirements of their customers. The credit quality also acts as a selling point the fund manager can use to pitch the fund to the investor.
Thus, the average credit quality is a measure of the creditworthiness of a fund and is an important parameter to be looked at before making investment decisions.