KEY POINTS:
With investment companies in New Zealand hitting the wall faster than mosquitoes into an electric bug zapper, the average Kiwi must be wondering how to tell a good investment from a bad one.
The answer is the credit police: the credit ratings agencies that rate everything from government to banks and other companies. In fact, any entity that wants
to borrow money from the public or money markets can get what's known as a "credit rating", which rank credit worthiness.
A poor credit rating means a high risk of defaulting and leads to them paying higher interest rates.
The firms with real kudos are international ratings agencies: Standard & Poors (S&P), Moody's Global Credit Research, and Fitch Ratings, which all carry out in-depth research into the balance sheets of those who seek credit ratings.
Having said that, credit ratings do give investors some form of protection in that
they allow you to compare the safety and security of investments.
Investors should be wary of companies with flashy secure sounding names, but no credit rating. Examples of these were Bridgecorp, Numeria Finance, and Capital+ Merchant Investments, which have all gone under.
They all tried to pass themselves off as super safe. But the lack of a credit rating
from a reputable agency should be a red flag to investors - no matter how flash their marketing material.
It's important not to take credit ratings at face value. In the old days at school an A-C grade was a pass and a D, E or F, a flunk.
Not so with ratings agencies. Standard & Poor's ratings system, for example, starts at AAA for the lowest risk investments and goes down to AA, A, and then BBB. Anything below this such as BB or B is "high risk" and called a "junk bond". One finance company that got into strife last year, Geneva Finance, was boasting it had a B+ rating. Few naïve investors would have realised this meant the company had flunked S&P's test.
Even the big three make mistakes. They underestimated the risks posed by investments backed by sub-prime loans. The investments, called quot;collateralised debt obligations" crashed in value and the credit agencies have had to downgrade many.
The other trouble with ratings from the big three is that they cost tens of thousands of dollars and some small companies can't afford them. Others fear that the results would scare investors away.
What some companies do is advertise ratings from second-tier agencies such as Rapid Ratings, Axis Ratings, and Grosvenor BondWatch.
A matrix of all of them will give investors an idea of a company's credit worthiness, but shouldn't be relied upon especially for large lump sum investments.
As individuals, virtually everyone is rated by credit ratings agency Veda Advantage. Companies that we may want to borrow money from or buy services, such as electricity supply, check our credit ratings.
It holds information such as:
" Identity details such as name, date of birth, current and previous addresses,
employment and occupation
" Past credit applications
" Your default history if any
" Public record information such as bankruptcy, judgements, and directorships
Individuals can access information on their credit file for free from mycreditfile.co.nz.
