(Editor's notes: These criteria have been superseded by the article titled "Fixed-Income Funds: Methodology And Assumptions: Fund Credit Quality Rating Criteria," published on April 20, 2011)

2007/03/29

Credit quality
The most important analytical task in completing a fixed-income fund rating is determining the credit quality of the individual securities held. The credit quality of investment assets will largely be based on an assessment of their default risk, which will be derived from TRC credit ratings or confidential credit assessments.

Counterparty risk
TRC looks at the counterparties to transactions, such as custodians and providers of repurchase agreements (repos). The concern is that a counterparty default could cause an economic loss to the fund, When evaluating a repurchase agreement, TRC focuses primarily on the credit quality and structural soundness of the transaction. To ensure that repurchase agreements are properly secured, TRC looks to see that the fund has taken all the necessary steps to maintain a first perfected security interest in any repo securities. As a general guideline, TRC views all investments relating to repurchase agreements as assets of the fund.

Liquidity
The liquidity of a portfolio is also of critical importance in determining market price exposure, because the degree of liquidity can affect the market value of investments. TRC takes into consideration the types of investments, their maturity structure and diversification. It is expected that the higher rated fixed-income funds will have greater exposure to the more liquid forms of investments, such as government securities.

Portfolio manager evaluation
Essential to any analysis of a managed portfolio is an understanding of the portfolio manager. The focus of this assessment is on the portfolio manager's ability to implement a portfolio strategy that is consistent with the fund's stated investment goals and objectives. Portfolio managers should be familiar with the redemption patterns of their investor base, so as to manage cash flow volatility.

Fund management company assessment
TRC's analysis is also sensitive to the quality of the related fund management company. While the fund is a legally distinct entity, experience suggests that public confidence can be impacted by the financial standing of the related fund management company. TRC closely examines the group's organizational structure, the size and capabilities of its research staff, track record in portfolio management, operating procedures and internal controls. A fund management company should have internal controls that clearly segregate the operations of the fund from the rest of the group.

Legal structure
TRC expects that all funds will have an appropriate and approved trust deed, established in accordance with Securities and Futures Commission (SFC) regulations and requirements. The assets of the fund must be for the benefit of unit holders and segregated from any claims by creditors or other parties.

Industry characteristics
The criteria take into consideration the special characteristics of the Taiwan fixed-income fund industry, In particular, TRC examines the extensive use of repurchase agreements in the absence of an active secondary bond market, and the influence of tax driven investors on the maturity profiles of funds. When evaluating a fund's credit quality, TRC looks at the underlying securities used in repurchase agreements. The credit quality of the counterparties to the repurchase agreement is also examined. More emphasis is placed on liquidity requirements because of the relatively short maturity profiles of Taiwan fixed-income funds.

Information requirements

The following is some of the key information required for the rating analysis:

Documents

·         Prospectus or information memorandum

·         Trust deed

·         Custodian agreement

·         Repurchase agreement

·         Guarantee agreement

Financial information

·         Audited financial accounts of the fund for the past five years (if applicable)

·         Audited financial accounts of the fund management company for the past five years (if applicable)

Statistical information

·         Fund's growth pattern for the past five years ( if applicable)

·         Current list of portfolio holdings, including repurchase agreement securities

·         Current portfolio maturity distribution

·         Number of unit holders, and percentage of fund held by each of the 10 largest unit holders.

·         Subscription and redemption history on a monthly basis for the past five years ( if applicable)

·         Unit price of the fund on a monthly basis for the past five years ( if applicable)

·         Average yield per annum on a monthly basis for the past five years ( if applicable)

General information

·         Biographies and organizational chart for key employees (chief executive officer, Chief investment officer, fund manager and senior research staff)

·         Policies regarding internal controls and operating procedures

·         Policies regarding the fund's investment strategies

The rating process

TRC will assign a rating, only when the fund management agrees to provide the necessary portfolio information on a timely basis. The rating process begins when TRC receives an executed Rating Agreement Letter, requesting to have a particular fund rated. At this point, the analyst assigned to the fund asks for certain pertinent information regarding the fund.

Upon analysis of the information, the analyst schedules a management meeting with fund officials. The analyst next discusses the fund with a rating committee composed of senior TRC and Standard & Poor's Managed Fund analysts. The committee examines all relevant information found in the rating process. Following the analyst's rating presentation, the committee votes on a final rating.

If the proposed rating does not meet the fund's expectations the fund may appeal. During the appeal process, TRC refrains from publishing the rating until it reviews any new information the fund makes available. However, TRC does not guarantee that the additional information will alter the rating committee's decision.

Surveillance
Once a rating is issued, TRC will continuously monitor the fund and send out monthly surveillance forms. This is so as to ensure that any changes in the portfolio or the fund management's operating policies do not alter the fund's rating. TRC also conducts a yearly management review and portfolio strategy meeting to review any changes made during the year.