What Is a Weighted Average Credit Rating (WACR)?
The weighted average credit rating (WACR) is the average rating assigned to all bonds in a bond fund. This grading technique gives investors a sense of the credit quality of a fund. It also helps in determining the overall risk of a bond portfolio. The lower a bond fund’s weighted average credit rating, the riskier it is. The weighted average credit rating is denoted by a letter rating, such as AAA, BBB, or CCC.
- A weighted average credit rating, denoted as AAA, BBB, or CCC, informs investors about a fund’s overall credit quality.
- The weighted-average credit rating is determined by taking the proportion of the value of each individual credit rating and dividing it by the total portfolio value, yielding the average credit rating.
- Some criticize weighted average credit ratings because they may confuse investors who do not fully grasp the grade.
- Linear factors, which are given to a rating level based on default likelihood, are also used to establish a fund’s credit quality.
How a Weighted Average Credit Rating (WACR) Works
The calculation of a weighted average credit rating differs across the financial industry. In general, the weighted average credit rating takes into account the proportion of each credit rating’s value as a percentage of the whole portfolio. The fund may calculate the average credit rating using separate rating weights.
A weighted average credit rating might help investors determine a bond fund’s genuine credit quality.
The weighted-average credit rating is not the only statistic available to investors when determining a fund’s credit quality. A linear component may also be used in weighted average credit rating computations by statistical reporting firms. This process, which is conceptually similar to traditional weighted average computations, determines the proportionate weight of the value of each rating level.
A linear factor is applied to each rating level based on the rating default probability in linear factor calculations. The proportionate credit ratings of the bonds in the portfolio determine the average linear factor. The matching linear factor is then used to calculate the weighted-average credit rating.
Criticism of Weighted Average Credit Ratings
This form of ranking is not without debate. Because of the potential for investor misunderstanding, the weighted-average credit rating procedure has been contested in the bond fund sector. A weighted average rating approach may assess all of the available rating classes in which a fund might invest. As a consequence, the fund may not have any bonds in the designated weighted average rating category, which may cause confusion among people seeing the tabulated statistics.
Example of a Weighted Average Credit Rating (WACR)
A bond with 25% AAA, 25% BBB, and 50% CCC might have an average credit rating of B+, which is between BBB and CCC. Because the fund does not own any B+ bonds, this may not be a suitable representation for investors. As a result, most bond funds provide a scale with credit rating weightings in their marketing brochures. This allows investors to comprehend the concentration of bonds by rating rather than merely looking at the weighted average credit rating data.
The Vanguard Long-Term Corporate Bond ETF is a major bond fund with assets exceeding $6 billion. In its marketing materials or fund reporting, the fund does not disclose a weighted average credit rating. Instead, it contains the scale below, which depicts its credit quality dispersion as of December 31, 2020.
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