TRC Corporation Rating Criteria Bond Fund Ratings
Methodology
Introduction
Taiwan Ratings Corporation (TRC) is Taiwan's first credit rating agency.
The company is a joint venture between Standard & Poor's, the world's
leading credit rating agency, and the Taiwan Stock Exchange, the Taiwan
Securities Central depository Company, China Credit Information Services,
Joint Credit Information Center, the Over-the-Counter Securities Exchange,
and the Securities and Futures Institute. This brochure identifies and
addresses some of the specific factors considered by TRC in rating bond
funds.
What is a bond fund rating?
A TRC bond fund rating is a current assessment of the overall credit quality
of a fund's portfolio. The rating reflects the level of protection against
losses from credit defaults and is based on an analysis of the credit
quality of the portfolio of investment. In conjunction with this analysis,
TRC also reviews counterparty risk, liquidity, management and the fund's
legal structure (refer to rating methodology).
TRC does not assign a separate market risk rating with the credit quality
rating. A bond fund market risk rating is an assessment of a fund's total
return and net asset value variability to market risks such as interest
rate risk.
A TRC bond fund rating has an "f" subscript (for fixed income) so as
to clearly distinguish them from other types of ratings. The "tw" prefix
indicates that these funds are rated using the Taiwan domestic rating
scale and are not directly comparable to ratings assigned in the context
of an international scale.
Definitions for TRC bond fund credit rating are as follows:
twAAAf
The bond fund provides extremely strong protection against losses from
credit defaults relative to other Taiwanese bond funds.
twAAf
The bond fund provides very strong protection against losses from credit
defaults relative to other Taiwanese bond funds.
twAf
The bond fund provides strong protection against losses from credit defaults
relative to other Taiwanese bond funds.
twBBBf
The bond fund provides adequate protection against losses from credit
defaults relative to other Taiwanese bond funds.
twBBf
The bond fund provides uncertain protection against losses from credit
defaults relative to other Taiwanese bond funds.
twBf
The bond fund is vulnerable to losses from credit defaults relative to
other Taiwanese bond funds.
twCCCf
The bond fund is extremely vulnerable to losses from credit defaults relative
to other Taiwanese bond funds.
Funds are placed on CreditWatch when an event occurs or is expected to
occur and additional information is required. For example, a bond fund
may be placed on CreditWatch as a result of a change in investment approach
or significant downgrades in commonly held securities. CreditWatch designations
may be "positive", indicating a rating may be raised or "negative", indicating
a rating may be lowered. "Developing" is used for unusual situations where
future events are so unclear that a rating may potentially be raised or
lowered.
Credit ratings are not a recommendation to purchase, sell, or hold a
financial obligation, as ratings do not comment on market price or suitability
for a particular investor. Ratings are based on current information furnished
to TRC by the fund management company, the portfolio manager or obtained
by TRC from other sources it considers reliable. TRC does not perform
an audit in connection with any rating and may, on occasion, rely on unaudited
financial information. TRC does not guarantee the accuracy of the information
relied upon in assigning ratings.
Use of a bond fund rating in a prospectus or in marketing material is
permitted. However, the full rating, together with a summary of the rating
definition, should be included in the documents.
The benefits
The dynamic expansion of the mutual funds industry has confronted investors
with an overwhelming number of investment options. Choosing the right
fund to meet investor's income and capital needs has become increasingly
difficult. In this environment, TRC credit information provides clear
benchmarks for decision making. Ratings will be especially useful to investors
governed by specific policy guidelines regarding the credit quality of
their investments.
Ratings will also provide fund management companies with a key marketing
tool, allowing them to differentiate their products in terms of risk,
and target investors needs more accurately. For example, ratings will
allow fund management companies to differentiate between low risk funds,
designed to preserve capital and limit downside risk, and the higher risk
growth funds.
Increasing competition, especially from foreign banks and fund management
groups, is making fund managers look at different ways to sell their products.
Over time, ratings will become and important strategic marketing tool
in enhancing client service.
Rating methodology
Credit quality
The most important analytical task in completing a bond fund rating is
determining the credit quality of the individual securities held, The
credit quality of investment assets will largely be based on an assessment
of their default risk, which will be derived from TRC credit ratings or
confidential credit assessments. In general, the rating assigned to a
fund cannot be higher than the combined quality of the assets held.
Counterparty risk
TRC looks at the counterparties to transactions, such as custodians and
providers of repurchase agreements (repos). The concern is that a counterparty
default could cause an economic loss to the fund, When evaluating a repurchase
agreement, TRC focuses primarily on the credit quality and structural
soundness of the transaction. To ensure that repurchase agreements are
properly secured, TRC looks to see that the fund has taken all the necessary
steps to maintain a first perfected security interest in any repo securities.
As a general guideline, TRC views all investments relating to repurchase
agreements as assets of the fund.
Liquidity
The liquidity of a portfolio is also of critical importance in determining
market price exposure, because the degree of liquidity can affect the
market value of investments. TRC takes into consideration the types of
investments, their maturity structure and diversification. It is expected
that the higher rated bond funds will have greater exposure to the more
liquid forms of investments, such as government securities.
Portfolio manager evaluation
Essential to any analysis of a managed portfolio is an understanding of
the portfolio manager. The focus of this assessment is on the portfolio
manager's ability to implement a portfolio strategy that is consistent
with the fund's stated investment goals and objectives. Portfolio managers
should be familiar with the redemption patterns of their investor base,
so as to manage cash flow volatility.
Fund management company
assessment
TRC's analysis is also sensitive to the quality of the related fund management
company. While the fund is a legally distinct entity, experience suggests
that public confidence can be impacted by the financial standing of the
related fund management company. TRC closely examines the group's organizational
structure, the size and capabilities of its research staff, track record
in portfolio management, operating procedures and internal controls. A
fund management company should have internal controls that clearly segregate
the operations of the fund from the rest of the group.
Legal structure
TRC expects that all funds will have an appropriate and approved trust
deed, established in accordance with Securities and Futures Commission
(SFC) regulations and requirements. The assets of the fund must be for
the benefit of unit holders and segregated from any claims by creditors
or other parties.
Industry characteristics
The criteria take into consideration the special characteristics of the
Taiwan bond fund industry, In particular, TRC examines the extensive use
of repurchase agreements in the absence of an active secondary bond market,
and the influence of tax driven investors on the maturity profiles of
funds. When evaluating a fund's credit quality, TRC looks at the underlying
securities used in repurchase agreements. The credit quality of the counterparties
to the repurchase agreement is also examined. More emphasis is placed
on liquidity requirements because of the relatively short maturity profiles
of Taiwan bond funds.
Information requirements
The following is some of the
key information required for the rating analysis:
Documents