Impact of changes to debt rating
On Friday night, Fitch downgraded the government debt rating for the UK to AA- from AA. Fitch is one of the top three independent agencies (the others being Moody’s and Standard & Poors) that assess the risk of companies or governments not being able to pay back their debt. It is nothing to worry about for the UK as our debt is still close to the top rating on a scale that runs from AAA to BBB in investment grade with 11 possible levels based on intermediate classifications of +/-. The Fitch ratings break down as shown below. Each agency has its own scale, but they tend to agree on the level of rating to apply to each issuer
- AAA : the best quality companies, reliable and stable
- AA : quality companies, a bit higher risk than AAA
- A : economic situation can affect finance
- BBB : medium class companies, which are satisfactory at the moment
- BB : more prone to changes in the economy
- B : financial situation varies noticeably
- CCC : currently vulnerable and dependent on favourable economic conditions to meet its commitments
- CC : highly vulnerable, very speculative bonds
- C : highly vulnerable, perhaps in bankruptcy or in areas but still continuing to pay out on obligations
- D : has defaulted on obligations and Fitch believes that it will generally default on most or all obligations
- NR : not publicly rated
These ratings may influence the level of compensation (yield) that investors require from the company or government to hold their debt. In the case of a country it may also impact the value of its currency, meaning a downgrade could cause it to fall in value, at least in the near term.
With regard to the UK downgrade, Fitch stated:
“The downgrade reflects a significant weakening of the UK's public finances caused by the impact of the Covid-19 outbreak and a fiscal loosening stance that was instigated before the scale of the crisis became apparent,”. They go on to say it also “reflects the deep near-term damage to the UK economy caused by the coronavirus outbreak and the lingering uncertainty regarding the post-Brexit UK-EU trade relationship."
Many countries are having to restrict freedom of movement to combat the spread of the virus and this has led to a sudden loss of economic activity. To counter the impact of this, governments and central banks have provided unprecedented levels of monetary and fiscal support that will push up debt levels. For any entity the combination of more debt and less revenue is a bad for investors and should lead them to require a higher level of yield to compensate for holding the debt of that entity.
Ultimately there will be a slew of ratings downgrades for many countries and companies during this period of disruption. Just last week Moody’s downgraded a number of European nations and South Africa was cut to junk (non-investment grade). The impact for the UK from being downgraded is likely to be small given that our debt is regarded as high-grade quality, even at the lower rating. Where the rating becomes more of an issue is when a country or company moves from investment grade to non-investment grade or junk status as was the case with South Africa. As that level the ratings agencies are signalling a higher risk that the entity will not be able to service its debt and you would expect a bigger reaction from markets in terms of higher yields and currency weakness.
It remains to be seen what impact the downgrade has on UK assets, but we expect it to be short-lived. Your portfolio of investments is designed to be diversified across regions of the world and depending on your attitude to risk to include a range of different assets designed to spread risks. This means that your exposure to any individual event like this is reduced.
Chief Investment Officer
Omnis Investments Limited
Issued by Omnis Investments Limited. This update reflects Omnis’ view at the time of writing and is subject to change. The document is for informational purposes only and is not investment advice. We recommend you discuss any investment decisions with your Openwork financial adviser. Omnis is unable to provide investment advice. Every effort is made to ensure the accuracy of the information but no assurance or warranties are given. The value of an investment and any income derived from it can fall as well as rise and you may not get back the original amount invested. Past performance is not a guide to future performance.
The Omnis Managed Investments ICVC and the Omnis Portfolio Investments ICVC are authorised Investment Companies with Variable Capital. The authorised corporate director of the Omnis Managed Investments ICVC and the Omnis Portfolio Investments ICVC is Omnis Investments Limited (Registered Address: Washington House, Lydiard Fields, Swindon, SN5 8UB) which is authorised and regulated by the Financial Conduct Authority.