Decoding Debt Funds credit rating

Are you scouting for an investment vehicle that allows you to earn good market-adjusted returns? Invest in Mutual Funds and consider the following types: Equity, Debt, and Hybrid Funds. Each type differs based on the returns they offer, and the risk involved. This ensures there is something suitable for every investor. Debt Funds are the most popular Mutual Fund. They are a low-risk investment option that offers reasonable returns.

When investing in Debt Funds, you notice that every Debt instrument has a credit rating. Let us understand what it means.

What are credit ratings?

Debt instruments work on a fixed maturity date and interest rate. They are not linked to market fluctuations. However, they involve some risk due to the default possibility. Default is when the Debt issuer does not disburse the principal investment and interest. In such a scenario, you are likely to bear a huge loss. To avoid this, always check the credit rating for the Debt instrument before investing.

Credit ratings help establish the credibility of the Debt issuer. A higher credit rating indicates lesser chances of default and vice-versa. Hence, you should always invest in Debt Mutual Funds of a higher rating to secure investment.

How are Debt instruments classified based on credit rating?

Since investment horizon has a major say over a fund’s risk profile, short-term and long-term Debt instruments are classified into different credit rating categories.

Short-term credit rating:

  • A1 – High degree of safety, lowest credit risk
  • A2 – Good degree of safety, low credit risk
  • A3 – Moderate degree of safety, slightly risky
  • A4 – Low degree of risk, very high credit risk
  • D – Very likely to default

Note: You may notice a plus symbol besides some credit ratings. This indicates the instrument is better than other instruments in the same tier. For example, an online Mutual Fund with a credit rating of A1+ is better than an A1 instrument.

Long-term credit rating:

  • AAA – Maximum degree of safety, minimal credit risk
  • AA – High degree of safety, lowest credit risk
  • A – Good degree of safety, low credit risk
  • BBB – Moderate degree of safety and credit risk
  • BB – Moderate risk of default
  • B – High risk of default
  • C – Very high risk of default
  • D – Most likely to default

Note: Here again, you may notice a plus or minus symbol besides some credit ratings. This indicates that the instrument is far better or lower than other instruments of the same tier.

For example, AAA+ is better than an instrument with an AAA rating, while AAA – is a notch lower than an instrument with a AAA rating. Your aim should always be to invest in a Debt instrument with an AAA+ rating, as it offers maximum investment security.

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