What is a Weighted Average Credit Rating
The weighted average credit rating is the weighted average rating of all the bonds in a bond fund. The measure gives investors an idea of a fund’s credit quality and helps to identify how risky a bond portfolio is overall. The lower the weighted average credit rating, the riskier the bond fund. The weighted average credit rating is expressed as a regular letter rating (AAA, BBB, CCC).
BREAKING DOWN Weighted Average Credit Rating
Weighted average credit rating methodologies vary throughout the industry. Generally the weighted average credit rating considers the proportion of the value of each credit rating as a percentage of the total portfolio. With individual rating weights the fund can determine the average credit rating.
Weighted average credit rating has been disputed in the bond fund industry because of the potential for investor confusion. A weighted average rating methodology can take into consideration all the potential rating classifications a fund can invest in. Therefore, the fund may not hold any bonds in the specified weighted average rating category.
For example, 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.
The Vanguard Long-Term Corporate Bond Index Fund is one of the top performing bond funds in 2017. The Fund does not provide a weighted average credit rating in its marketing materials or fund reporting. Instead it includes the following scale which shows its credit quality dispersion.
U.S. Government 0.1%
< Baa 0.0%
Statistical reporting companies may also integrate a linear factor into weighted average credit rating calculations. Similar 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 ratings default probability. An average linear factor is determined by the proportional credit ratings of the bond’s in the portfolio. The weighted average credit rating is then determined by its corresponding linear factor.