Responsible Management Education

Should Credit Ratings alone be used for Investment Decisions??

Credit ratings are not investment recommendations rather they serve as one of several tools that investors can use when making decisions regarding investing in debt funds or any other investments. The ratings agencies only provide an independent opinion on the credit quality of the investment instruments issued by the issuers. Therefore, the investment decision should be based on many other factors such as liquidity in the market and interest rate fluctuations apart from credit risks. The credit rating provides information regarding the companies in the form of rating symbols which is easily recognizable by the investors to perceive risk involved in investments.

Credit ratings are useful for evaluating any investment, but the investors should not base their investment decisions solely on rating symbols or treat credit ratings as if it was an advice to invest in a particular security. This is because credit ratings also have certain limitations of their own.

Credit ratings provide only an alternative viewpoint to the financial analysis and enable the investor to compare risks in investment portfolios. Also credit ratings address only credit risk and give no insights on other risks associated with an investment such as liquidity risk, market risk etc.

Due to the subjective nature of credit ratings, their accuracy and performance is not measurable, thus making it difficult to compare them across different industry sectors.

Securities and Exchange Board of India (SEBI) has completely changed its position on the importance of the credit ratings given by the credit ratings agencies in India. From time to time, SEBI has imposed many regulations and circulars for regulating the credit rating agencies in India and to protect the interest of the investors. Despite of the fact that SEBI circulars & regulations plug many loopholes but some lacunae remains.

What should investors do ?

  • Investors should not rely only on the credit ratings given by the credit rating agencies.
  • Investors should consider the financial performance of the company before investing in securities.
  • Investors should also track news and developments about the companies whose debt funds they have invested in.
  • Investors should check with suppliers regarding the financial distress which might affect the payments.
  • Investors should also enquire from the customers of the company regarding product and services.

In short, investors should consider the credit ratings given by various credit rating agencies to have a diverse view on the creditworthiness of an investment. The investors must understand that the credit ratings should be used as supplement and not as a replacement of their own judgment, research and analysis for taking any investment decision. Therefore, the investor must understand the nature of the investment and should only invest in what he understands.