AAA, AA, A, BBB, BB, B, FAA .......... No, this is not the ranting of an unhinged human being. These are very meaningful words, and are ubiquitous in financial newspapers. And not without reason.
Such words are the cornerstone of investor decisions.
They are called 'ratings' and are assigned by agencies such as Crisil, CARE, ICRA, Fitch -- that inform investors about the ability of companies to service debt -- meaning, payment of interest and repayment of principal -- on time.
Credit rating information is the ultimate clincher that helps investors, retail and wholesale alike, decide on or against investing in the fixed income instruments floated by corporates.
Retail investors have become wiser after burning their fingers in the early 1990s. Fly-by-night operators had lured investors with a plethora of fancy assured return investment schemes -- euphemistically called collective investment (plantation) schemes and fixed deposits -- by promising moony returns of 25 per cent or more.
Avaricious investors simply took the bait and pledged all their lifetime savings. More than a decade has passed since, but the struggle to get back their monies continues.
Given this nightmarish experience, investors have wizened up to the concept of credit worthiness of companies and its measurement via ratings.
No longer do they enter fixed income instruments swayed by just high returns. They want to be assured that their hard earned money is not only safe but will also fetch them a decent return.
Anxiety about the safety of their investments has prompted retail investors to pursue rating information keenly.
Single-handedly, it will be a tall order for the investor to scan and digest the economic, sectoral and company fundamentals to make investment decisions.
If the denouement by a rating agency on a corporate points to the possibility of a default, substantial risk, risk prone or inadequate safety of investments -- be it in fixed deposits, bonds, or debentures -- the informed investor will not even touch the issue with a barge pole.
Apprehension that their debt floats may not receive good response has resulted in even the bluest of blue-chip corporates going in for rating.
The importance of rating is underscored by the fact that almost 90 per cent of the private debt placement issues are rated. This despite there being no regulatory requirement on rating of private debt placement issues.
Even institutions such as IDBI, Sidbi, Nabard, National Housing Bank, National Highways Authority of India and the Rural Electrification Corporation, which are either backed by the sovereign or the central bank get their bond issues rated.
This only goes to show that rating is a tool to assure investors about the safety of their investments.
"Awareness among retail investors about credit ratings is increasing. Thousands of retail investors were duped of their precious savings in the early 1990s by dubious investment schemes. Hence, they want to be cocksure about the risk-return equation - higher the risk, higher the return and lower the risk, lower the return - before making an investment decision. Ratings help them make up their mind in this regard," said Mukesh Agarwal, head of corporate sector ratings, Crisil.
Retail investors, who are conservative, prefer to invest in the primary debt issuances of corporates, carrying the highest safety 'AAA' tag. Risk factors, in this case, are negligible but then the returns are also low.
As an investor's risk appetite increases, i.e., if he is willing to take a chance with his investible funds to earn higher returns, he may deploy funds in primary debt issuances of corporates with high safety 'AA', adequate safety 'A' and moderate safety 'BBB' labels.
Investment in the primary debt issuances of corporates, having ratings lower than the moderate safety tag, however, is fraught with grave risks.
Generally, companies that do not have a rating offer very high returns on investment.
Outlining the trend in the fixed income market, Agarwal points out that with cost-conscious corporates raising cheap resources via the private placement of non-convertible debentures, the fixed deposit route for tapping funds is drying up.
According to Rajesh Mokashi, executive director, Credit Analysis & Research Ltd, the ratings of corporates rests on four-prongs - business risk, financial risk, management evaluation, and the instrument terms.
A credit rating agency goes through all these parameters threadbare before assigning a rating. Hence, investors will do well to pursue the rating information.
Rating agencies are doing their bit to spread the importance of ratings.
They conduct investor awareness seminars and put out information about the ratings assigned and their rationale on their websites.
So the next time round, if you want to invest in fixed income instruments floated by a corporate, don't be taken in by the promise of high returns alone. Keep what the credit rating agency has to say about the health of a corporate in mind.
