There are three main credit rating agencies: Standard & Poor’s, Moody’s and Fitch. These agencies give ratings to the issuers of bonds according to the issuer’s creditworthiness.
Creditworthiness is a measure of the willingness and ability of an issuer to pay interest and principal.
For example, if a government is awarded an AAA rating by Standard & Poor’s, it is regarded as being extremely unlikely to not be able to pay back its bond holders. On the other hand, a company with a B rating that has issued a bond would be seen as more of a risk and thus would offer a higher coupon.
Ratings of BBB or higher - the highest is AAA - are termed ‘investment grade’, whereas those of BB or lower are referred to as ‘high yield’, as bonds of a lower credit quality typically yield more than their higher quality counterparts.
However not all bonds have a rating. Some bonds will not have a rating from a recognised agency, typically because of their small issue size making a rating economically not viable.
Alex Robertson, client portfolio manager of Royal London Asset Management, said it was a common misconception that the absence of a rating made a bond more risky.
“In fact, unlike rated bonds, many unrated securities have attractive structural characteristics and offer genuine credit enhancements.
“Some unrated bonds have a charge on specified assets, such as a property portfolio, meaning that they should provide superior recovery characteristics in the event of default.
“Such secured bonds also benefit from strong covenants that require the maintenance of asset values in excess of debt outstanding and restrict the issuer’s ability to increase indebtedness.”
