Should we fear the downgrade?

This article is part of
Sovereign Rating Agencies - April 2013

Anyone who doubts the political influence wielded by the major rating agencies needs look no further than the way chancellor George Osborne was harangued on Budget Day over the loss of the UK’s AAA rating from Moody’s this February.

Furthermore, with Fitch Ratings having just flexed its muscles to follow suit at the time of writing by placing the UK’s AAA rating on ‘negative outlook,’ such expressions of discontent are only likely to grow louder.

Nevertheless, sovereign credit ratings, which aim to provide an independent view of the creditworthiness of a country’s government bonds, have only limited influence in investment circles.

Some fund managers pay no attention to them at all and, while others – particularly bond fund managers – take them into account, they are merely one of numerous factors in their decision making.

David Dale, head of wealth management at Dickinson Dees, says: “The ratings have more impact on bonds than on equities as bonds tend to react more to negative news, and financial strength is the main criteria even with corporate bonds. Equity investors, on the other hand, are normally looking six months to a year ahead and are taking into account a greater range of other factors, including future earnings growth.”

Sovereign ratings also tend to command more attention from private client investment managers than from asset managers and institutional houses generally – who are far more likely to do their own in-house research on countries.

Association of Private Client Investment Managers and Stockbrokers (Apcims) chief executive Tim May says: “Our members would look more at liquidity and settlement arrangements than they would at solvency. So the ratings are important because they would use them to an extent to assess solvency.”

Although the ratings try to provide a common and transparent language for evaluating and comparing the risks of governments not repaying their debts in time or in full, this aim is not helped by the fact that investors must consider subjective opinions from three different major agencies – Standard & Poor’s, Moody’s and Fitch Ratings. Because each one uses slightly different criteria to arrive at its decisions, the exact implications of ratings actions are much less clear than they would be if they came from a single objective source.

Other criticisms include the fact that rating agencies tend to merely confirm what the market already knew months beforehand and that they have not exactly covered themselves in glory by failing to issue warnings on crucial issues such as the US subprime housing market catastrophe.

Richard Lewis, head of global equities at Fidelity, says: “There is virtually no new information for the market when rating agencies adjust sovereign ratings because it’s always done very late in the day. When the UK lost its AAA rating the market learned nothing new and the impact was absolutely negligible. The same happened when the US and France lost AAA ratings, and this is a very consistent pattern.”

Edmund Tirbutt is a freelance journalist