genuine question. AA rating is sold as the safe end of corporate bonds. but DHFL was AA rated before it collapsed. IL&FS subsidiaries had AAA ratings. so what does the rating actually tell you and what does it not tell you?
The rating tells you the agency’s view of the issuer’s ability to service debt at the time of rating. It does not tell you what will happen in two years if the business environment changes, if there is fraud, or if the management takes on excessive leverage after the rating was issued.
DHFL and IL&FS are the right examples to bring up. Both had high ratings that reflected the information available at the time. What the ratings did not capture was the pace of deterioration and in DHFL’s case, alleged fraud that was not visible in disclosed financials. Rating agencies rely on what issuers report. That is a structural limitation.
so the rating is basically only as good as the disclosure. if a company hides things the rating means nothing
That is a bit harsh but not entirely wrong. What I have learned over the years is to treat the rating as a starting point not a conclusion. I look at who the promoter is, how long they have been in business, whether the business model is straightforward or complex, and whether the auditor is a reputable firm. A AA from a company with a 20 year track record and a Big Four auditor is very different from a AA from a two year old NBFC with a lesser known auditor.
There is also a difference between secured and unsecured AA bonds. A secured bond has specific assets pledged against it. In a default scenario, secured bondholders have a legal claim on those assets before unsecured creditors. An unsecured AA bond is riskier than a secured one at the same rating. This distinction matters more than most retail investors realise.
so even within AA there is a spectrum
secured AA from an old boring company vs unsecured AA from a newer NBFC are basically different products
Manu’s read is right. the practical filter I use:
AA or above, secured where possible, promoter track record of more than 10 years, auditor quality, and I never put more than 15 to 20% of my bond portfolio in a single issuer regardless of rating.
concentration risk kills you faster than credit risk in most cases.
AA = lower risk, not zero risk
secured > unsecured at the same rating
old company with track record > new company with good numbers
don’t put all eggs in one issuer
rating is a filter not a guarantee