Understanding the role of credit rating agencies

Credit rating agencies have long been relied on to deliver reliable analysis for risk management and debt investment. However, a number of ratings firms have come under scrutiny in recent years for missing the mark on a series of credit assessments. The financial collapse of 2008 was, in many ways, allowed to unfold because of the insistence by a number of ratings agencies in the strength of various debt securities that ultimately tanked. More recently, Standard & Poor's, the country's top rating firm, downgraded U.S. debt to a AA+ rating - a move that drew significant criticism from economists. However, other analysts maintain that ratings firms should not be championed as the final say in the value of an investment and that due diligence on the part of bondholders should be commonplace. "Investors ought not to use credit ratings as a substitute for proper credit analysis," writes Stephen Horan, head of university relations and private wealth at CFA Institute, told the Financial Times. "Monetary, fiscal, political and currency considerations make rating sovereign debt more complex than corporate debt." Fund managers can better gauge credit ratings by understanding their limitations, Horan adds.