Rating agencies giving a security or a company a particular rating gives investor a measure of how credit worthy such a security or company is. If the security is investment grade, it can be assumed that the probability of the security going default is much lower then a non-investment grade one. The key word is “probability”. Rating agencies are not gods and hence cannot guarantee that a particular company or security will not fail. All they can give is a statistical probability of likelihood. The statistic becomes meaningful if one hold a large basket of similar rating securities. If the probability of the company going default is 2%, then if the basket contains 1000 securities, then by law of large numbers one would expect 20 companies to go burst. Sounds good so far. Unfortunately in real life this was far from expectation. The CDOs (now call SIVs) were given high ratings by their rating agencies. Many of which were investment grades. However right now a huge number of it has gone into defaults. It sounds to me that these CDOs were in the first place junk-bonds (i.e. non-investment grade). What really happen? I think it has to do with conflict of interest. Rating agencies are paid by the same party whom they need to rate.

Conflict of interest is everywhere. Everyday I receives tons of “market updates” from fund managers with vested interest. I remember that a particular fund house keep on promoting their property fund non-stop and then suddenly the party stopped. The fund noise dive like nobody business incurring a lost of 30% over a six months period. The fund manager didn’t even give a any warning. I felt really cheated by such fund house. Actually, no fund manager will ever give a bearish view of the market if they are managing a fund in that same market. What should investor do? I think there is really NOTHING an investor can do since it is impossible to distinguish between a biased market view and an unbiased one.  Market information from fund houses and write-ups by portals in the business of selling investment products are likely to be tainted with biased market views. If we seek news from the media like Bloomberg it will be even more terrible as the noise level will cause a severe indigestion!

I would say that it is most important to have a well constructed asset allocation. Not that this is the “best” way but I think that’s the only way to do it given information out there cannot be trusted anyway.