What is 'Credit Quality'

Credit quality is one of the principal criteria for judging the investment quality of a bond or bond mutual fund. As the term implies, credit quality informs investors of a bond or bond portfolio's credit worthiness or risk of default. A company or security’s credit quality may also be known as its “bond rating."

BREAKING DOWN 'Credit Quality'

Credit quality is an important aspect of the credit markets. An individual bond or bond mutual fund's credit quality is determined by private independent rating agencies such as Standard & Poor's, Moody's and Fitch. Each rating agency has its own credit quality designations which typically range from high ('AAA' to 'AA') to medium ('A' to 'BBB') to low ('BB', 'B', 'CCC', 'CC' to 'C').

Credit rating agencies issue credit quality ratings for all types of issuers in the credit market. Factors influencing a corporate credit rating include the company’s capital structure, credit payment history, revenue and earnings. (See also What Is a Corporate Credit Rating?)

Credit quality ratings for developed market countries, such as the U.S., are typically on the higher end of the credit quality spectrum and offer investors investments with low risk of default. In the credit market, investment-grade ratings are typically perceived as high quality. Non investment-grade bonds, also called high-yield or junk bonds, have lower credit quality and higher risk. Investment-grade bonds often have lower yields while non-investment grade bonds require higher yields for the greater potential risk.

Investors interested in the safety of their bond investments should stick to investment grade bonds ('AAA', 'AA', 'A', and 'BBB'), while other investors willing and able to accept a higher level of risk could consider lower credit-quality bonds with higher yields.

Credit Quality Investing

In the investable market, investors have a wide range of mutual funds to choose from with varying credit qualities. Mutual funds offer investors the opportunity to invest in a diversified portfolio of bonds with targeted credit quality exposure. Below are examples of some of the top bond funds in the government and high yield credit quality categories.

Eaton Vance Short Duration Government Income Fund

This fund focuses on short-term U.S. government debt. The Fund offers A, C and I share classes. It invests in high-quality, short-term U.S. government and U.S. government agency bonds. The Fund’s average duration is less than three years which gives it limited interest rate risk. As of December 4, 2017, the Fund had a one year return of 2.17%. Its expense ratio is 0.90%.

Highland Opportunistic Credit Fund

The Highland Opportunistic Credit Fund is one of the top performing funds in the high yield category. Its one year return as of December 4, 2017 was 15.28%. The Fund has an expense ratio of 1.30%. The Fund invests for total return. As of September 30, 2017, 28% of the Fund was invested in CCC securities.

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