Average credit quality gives a snapshot of the portfolio’s overall credit quality. It is an average of each bond’s credit rating, adjusted for its relative weighting in the portfolio. For corporate-bond and municipal bond funds, Morningstar also shows the percentage of fixed-income securities that fall within each credit-quality rating, as assigned by Standard & Poor's or Moody's. Because it's rare to find individual bonds in a portfolio with a rating below B, the average credit quality of bond funds in Morningstar's database ranges from AAA (highest) to B (lowest).
At the top of the ratings are AAA bonds. U.S. government bonds are also included within the AAA category (effective 6/30/06). Bonds with a B rating are the lowest bonds that are still considered to be of investment grade. Bonds that are rated lower than B (often called junk bonds or high-yield bonds) are considered to be quite speculative. Any bonds that appear in the NR/NA category are either not rated by Standard & Poor's or Moody's, or do not currently have a rating available.
Benefits
A bond’s average quality is a reflection of the amount of risk a fund is willing to incur, and management style in general. Average credit quality is also used to determine the vertical axis of Morningstar’s bond style boxes.
For The Pros
If a fund is investing in lower quality bonds, the expense ratio should be checked. Some funds with high expense ratios select riskier bonds to help cover their expenses.