What Is a Weighted Average Credit Rating (WACR)?
The weighted average credit rating (WACR) relates to the weighted average rating regarding all bonds in a bond fund. This rating procedure provides investors with an idea as to a fund’s credit quality. It also helps to identify the overall risk involved with a bond portfolio. The lower the weighted average credit rating, the riskier a bond fund is. The weighted average credit rating is designated in letter rating form, including AAA, BBB, or CCC.
- A weighted average credit rating provides investors with insight into a fund’s credit quality.
- A weighted average credit rating is designated as AAA, BBB, or CCC.
- The weighted-average credit rating is calculated by considering the proportion of the value of each individual credit rating and noting it as a percentage of the entire portfolio thereby producing the average credit rating.
- Weighted average credit ratings are questioned by some as they may cause confusion for investors who don’t thoroughly understand the rating.
- Linear factors are also used to determine a fund’s credit quality and are assigned to a rating level based on default probability.
How a Weighted Average Credit Rating (WACR) Works
How a weighted average credit rating is tabulated varies throughout the financial industry. In general, the weighted average credit rating takes into consideration the proportion of the value of each credit rating and considers it as a percentage of the total portfolio. With individual rating weights the fund can determine the average credit rating.
With a weighted average credit rating, investors can uncover the true credit quality of a bond fund.
The weighted-average credit rating is not the only statistic that investors have access to when understanding the credit quality of a fund. Statistical reporting companies may also integrate a linear factor into weighted average credit rating calculations. Similar in concept to standard weighted average calculations, this methodology identifies the proportional weight of the value of each rating level.
With linear factor calculations, a linear factor is assigned to each rating level based on the rating default probability. An average linear factor is determined by the proportional credit ratings of the bonds in the portfolio. The weighted-average credit rating is then determined by its corresponding linear factor.
Criticism of Weighted Average Credit Ratings
This type of rating is not without controversy. The weighted-average credit rating process has been disputed in the bond fund industry as a result of the potential for investor confusion. A weighted average rating methodology can take into consideration all of the potential rating classifications a fund can invest in. Therefore, the fund may not hold any bonds in the specified weighted average rating category and this can result in confusion by those who see the tabulated figures.
Example of a Weighted Average Credit Rating (WACR)
A bond with 25% of its value in AAA, 25% in BBB and 50% in CCC could have an average credit rating of B+ which is between BBB and CCC. This may not necessarily provide a good representation to investors since the fund does not hold any B+ bonds. For this reason, most bond funds choose to provide a scale with weightings by credit rating in their marketing materials. This helps investors to understand the concentration of bonds by rating and not just look to the results of the weighted average credit rating.
The Vanguard Long-Term Corporate Bond Index Fund was one of the top performing bond funds a couple of years ago. The fund did not provide a weighted average credit rating in its marketing materials or fund reporting. Instead it included the following scale which shows its credit quality dispersion: