Credit quality is an assessment of how well an entity can meet its debt obligations.
What is credit quality?
Credit quality measures an entity’s ability to pay off its debts consistently. This is an important factor for bond investors, as bonds allow investors to lend money out to a bond issuer under the agreement the issuer will repay the investor. Bonds with high-credit quality have issuing entities that consistently meet their debt obligations. Bonds with low-credit quality are issued by entities with a higher default risk. However, bonds with lower credit qualities may provide higher interest rates––and therefore yield––than bonds issued by entities with high credit quality.
A bond’s credit quality is determined by the credit rating of its issuing entity. These ratings are assigned by agencies such as DBRS Morningstar®, Moody’s, S&P Global Ratings, and Fitch Ratings.
For bond funds, Morningstar calculates the average credit quality by weighing each bond and its credit quality against all bonds in the portfolio. Investors can also use the Morningstar Fixed-Income Style Box to review their exposure to bonds with low-, medium-, or high-credit qualities.