What are mutual fund scheme ratings?

Credit rating agencies (CRAs) assign ratings to mutual fund (MF) schemes which invest entirely, or mostly, in debt. The ratings are based on the overall exposure to default risk, with regard to timely receipt of payments from the investments the scheme has made. CRAs such as Crisil, Icra and CARE have been rating long-term as well as short-term debt mutual fund schemes. So far, the ratings have been based on in-house parameters. Crisil rates MF schemes on a scale of 1 to 5, with 1 considered the best. Icra uses the grades AAA, AA, BBB and C, among others, to rate the same schemes.

Why is the rating of a scheme important?
Ratings help an investor assess the credit quality of a particular scheme before making an investment. Just like IPO grading, mutual fund grading looks at the past performance of the scheme. However, it does not talk about the possible future performance of a fund. Investors can examine the fund risk vis-à-vis their risk appetite.

Why the need for a standard rating symbol?
Last week, the Securities and Exchange Board of India (Sebi) asked CRAs to use standardized rating symbols. A common symbol is expected to help investors understand the ratings easily, apart from making the whole process fair.

According to the new symbols, long-term debt schemes with the highest degree of safety will be rated as AAAmfs. AAmf and Amf mean they have high and adequate levels of safety, respectively. BBBmfs and BBmfs-rated schemes carry moderate risk. A Bmf-rated scheme has high degree of risk. A scheme with Cmf rating has a very high level of risk. Rating companies can use the ‘+’ or ‘-’ symbol, along with the rating, to reflect the comparative standing within the category.

For a short-term debt fund scheme, a rating of A1mfs will be the highest. A2mfs and A3mfs-rated schemes reflect a strong and moderate degree of safety, respectively. A4mfs-rated schemes have the least degree of safety.

What are the criteria for rating a scheme?
Credit quality ratings are based on the evaluation of funds’ investment strategy and portfolio credit risk. It also involves analysing the credit quality of individual assets, diversification of portfolio, management quality and operational policies.