What Is a Weighted Average Credit Rating (WACR)?
Let me explain what a weighted average credit rating, or WACR, really is. It's the weighted average of the credit ratings for all the bonds in a bond fund. This gives you, as an investor, a clear idea of the fund's overall credit quality. It also points out the risk level in the bond portfolio. Remember, a lower WACR means the fund is riskier. We express this rating in letters like AAA, BBB, or CCC.
Key Takeaways
You should know that the WACR offers insight into a fund's credit quality, shown as ratings such as AAA, BBB, or CCC. We calculate it by looking at the proportion of each individual credit rating's value as a percentage of the whole portfolio, which gives the average. Some people question these ratings because they can confuse investors who don't fully get them. Also, linear factors come into play for assessing credit quality, assigned based on default probabilities.
How a Weighted Average Credit Rating (WACR) Works
The way we tabulate a WACR can differ across the financial industry. Generally, it considers the proportion of each credit rating's value as a percentage of the total portfolio. By weighting these individual ratings, the fund arrives at the average credit rating. This helps you uncover the true credit quality of a bond fund— that's important to keep in mind.
Special Considerations
The WACR isn't the only tool you have for understanding a fund's credit quality. Reporting companies might add a linear factor to these calculations. This is similar to standard weighted averages, as it identifies the proportional weight of each rating level's value. With linear factors, we assign a factor to each rating based on default probability. Then, we determine an average linear factor from the proportional ratings in the portfolio, and that corresponds to the WACR.
Criticism of Weighted Average Credit Ratings
This rating method has its share of controversy. In the bond fund industry, people dispute it because it can confuse investors. The methodology considers all possible rating classifications the fund might invest in. So, the fund might not actually hold bonds in the calculated average rating category, which leads to misunderstandings when you look at the numbers.
Example of a Weighted Average Credit Rating (WACR)
Take a bond fund with 25% in AAA, 25% in BBB, and 50% in CCC—it might average out to B+, which sits between BBB and CCC. But this doesn't always represent things well since the fund holds no B+ bonds. That's why most bond funds include a scale showing weightings by credit rating in their materials. This lets you see the concentration of bonds by rating, rather than just the WACR average.
Vanguard Long-Term Corporate Bond ETF Credit Quality Dispersion (as of December 31, 2020)
- U.S. Govt. 0.3%
- Aaa 2.7%
- Aa 9.1%
- A 37.4%
- Baa 50.5%
- < Baa 0.0%
- Total 100.0%
Final Note on Vanguard Example
Consider the Vanguard Long-Term Corporate Bond ETF, which manages over $6 billion in assets. It skips providing a WACR in its marketing or reports. Instead, it uses the scale above to show credit quality dispersion. This comes from Vanguard's data.
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