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Using ThinCats’ gradings

11th Nov 2016   ·   The ThinCats Team   ·   Insights

red-chairs-small.jpgYou want to go to cinema, but what to see? Easy – just pick the film with the highest rating. Five stars and you’re front and centre, with super large bucket of popcorn.

Western, scifi, romcom, action – doesn’t matter, just so long as it’s got the most stars.

No-one chooses a film like this, so why would you chose an investment on the same basis?

The above point is made to highlight a danger of total reliance on ThinCats’ star and padlock gradings, for credit and security quality respectively. We’ve put a lot of work into developing these, and we believe they are strongly predictive of outcomes in their respective areas. However, they are not a substitute for lenders’ own research, using the investment packs and other materials. They supplement this research.

For instance, a five-star loan is not ‘better’ than a four-star one. Our analysis, based on multiple quantitative metrics, shows the former to be a lower-risk one. Both should be priced accordingly. In the same way, an investment-grade bond is not better than a high-yield one; blue chip equity is not better than shares in small cap companies. It all depends on your risk tolerance and your investment objectives.

Crucially, it also depends on how a loan fits into your broader portfolio. Lenders should always be looking to build a diversified portfolio in order to arrive at a level of risk with which they are comfortable. It’s therefore inadvisable to invest in a loan just because it is underwritten – or on the basis if the institutions like a loan, then it must be good. An underwriter has its own clearly-determined investment strategy and portfolio guidelines. So if an institution invests in a loan, it will likely compliment or advance that strategy. However, that same loan, added to another very different individual portfolio, may adversely change the risk-reward trade-off of that portfolio.

Gradings are important and useful tools for the investor. But they are best used as a way of informing broader investment research. Your initial screening should not be your only screening.

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