Look beyond credit riskometer: Check ratings, yields and bond maturities

Read the rating rationale, compare yields and match maturities to when you need the money

The Securities and Exchange Board of India (Sebi) has introduced a credit riskometer for debt securities. The colour-coded display helps investors assess credit risk. While the riskometer provides a starting point, most investors should look beyond it when assessing a bond.   

How the meter works 

The credit riskometer maps ratings from AAA to D to six levels, from lowest credit risk to very high default risk. In cases where a bond has multiple ratings, the riskometer reflects the lowest one. Unsecured bonds display ‘unsecured’ in bold red.  

“A graphic, colour-based representation of ratings will allow investors to visually compare the risk between two bonds,” says Ankit Gupta, founder director, BondsIndia.  

 

“It will help those unfamiliar with rating symbols and terminology or lacking the expertise to conduct in-depth credit assessment,” says Shubham Gupta, co-founder and CEO, Growthvine Capital. 

Recognise its limits 

The meter reflects ratings, but does not capture every risk a bond carries, or changes in risk levels. “Bonds with the same colour may differ in repayment terms and issuer strength,” says Vishal Goenka, co-founder, IndiaBonds. The riskometer also does not reflect interest rate risk.  

“The display shows where a rating stands today, but cannot predict where it will stand tomorrow,” says Prashant Mishra, founder and CEO, Agnam Advisors. Many past defaulters held top-tier ratings shortly before they defaulted. 

 

Guard against downgrades 

Treat the riskometer and ratings as a minimum check. Ankit Gupta suggests reading the rating rationale for a fuller perspective on all the risks a bond carries.  

“Watch market signals, which usually move before rating agencies,” says Mishra. Treat negative outlooks or rating watches as warnings.  

Limit each issuer to 5–10 per cent of the bond portfolio. Diversify across issuers and corporate groups. Choosing a bond with a shorter tenure is safer as it means there is less time for things to go wrong.  

Dealing with rate risk  

Longer-maturity bonds fall more when rates rise. Match maturity to your horizon. “Interim prices matter less if you hold the bond to maturity,” says Goenka.  

Allow for limited liquidity 

Corporate bonds can become illiquid, particularly during periods of market stress. “Higher-rated bonds generally offer better liquidity,” says Goenka. Diversify investments to mitigate individual bonds’ liquidity risk.  

Compare yields 

Compare the yields offered by similar bonds. “A higher yield, particularly as compared to another paper having the same rating or colour, signals that the market perceives greater risk,” says Joydeep Sen, financial market expert, corporate trainer and author. An AA-rated bond yielding as much as an A-rated bond may indicate risks its rating does not capture. 

Scrutinise issuer’s finances 

Check whether the company can repay debt from the cash it generates or depends on fresh borrowing. Persistent negative operating cash flows is a sign of trouble.  

For operating companies, check debt to earnings before interest, tax, depreciation and amortisation (EBITDA). A ratio above four to five times needs a good explanation. 

“Interest coverage below two times warrants caution, and below 1.5 times signals danger,” says Mishra.  

Be wary of companies that borrow short term to fund long-term loans. Such asset-liability mismatch has led to several defaults in the past. 

Avoid bonds if auditors resign or qualify accounts, results are delayed, or the company gives large loans to or guarantees group companies. “Covenant breaches and frequent rating downgrades should prompt closer scrutiny,” says Shubham Gupta. 

Check promoter’s background 

Check the track record of the promoter and the business group. A Google search can reveal adverse events or wrongdoing.

“Lay investors unable to conduct due diligence should invest through a professional manager of a mutual fund, portfolio management service (PMS) or alternative investment fund (AIF),” says Sen.