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‘#AskHansi’: What is the difference between credit ratings and mutual fund ratings?

Yahoo, in association with Hansi Mehrotra, presents ‘#AskHansi’, a new series to help you get a better grasp of personal finance and how you can invest smartly.

Hansi Mehrotra, a CFA with global experience and founder of The Money Hans, is a celebrity in the world of personal finance in India. A powerful influencer on in the corporate/banking/finance circles. She creates fine personal finance content that simplifies complex issues into easy-to-understand stuff which lay people can identify with.

A - A credit rating applies to debt securities only. It reflects the probability of default. So it’s the likelihood of this company or entity returning capital and interest on time. A credit rating is given by credit rating agencies (CRAs) like S&P, Moody's and Fitch. Some governments or government entities mandate the use of credit ratings when they're investing in certain securities. It (a credit rating) is based on a very tangible business.

On the other hand, a mutual fund rating is basically an assessment - an opinion - on fund managers’ ability to outperform their peers or a market index. Remember, the fund manager portfolios change on a day-to-day basis. So there's nothing ‘tangible’ that you're assessing. You're basically talking to the fund manager and assessing whether they have an investment philosophy that makes sense. And it's better than everybody else's.

Some mutual fund rating agencies assess the past performance or the holdings of the fund. But I think that's useless, because it changes so often. The environment has changed, the portfolios, the fund managers change, the competitors change... so basically useless. So, the star rating of one mutual fund rating agency could be very different from another.

So in a nutshell. A credit rating is based on tangible things (cash flows of a business), and probability of default. A mutual fund rating is based on intangible things and likelihood of out-performance. Very different.

Also read/watch -

Why you shouldn't invest in 5-star rated funds

The role of financial ratings