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When is a bond fund, not a bond fund? For that matter when is an American fund, no-longer just an American fund? These are just some of the questions advisors and investors will have to grapple with Morningstar Canada rolls out its fund categories competing against those set by the Canadian Investment Funds Standards Committee.
The Chou Bond fund will be one of the funds at the centre of the debate over whether it is in a Canadian investor’s best interest to support two competing fund categories.
The fund, managed by Francis Chou, one of Canada’s most successful money managers in recent years, is just one example of a fund being classified differently by the CIFSC and Morningstar, which will launch its new fund classifications in October.
Under the CIFSC’s revamped categories, the Chou fund is listed as a Canadian Bond fund, while Morningstar thinks the fund’s risk and investment profile make it best compared to the high-yield fixed-income category.
David O’Leary, a senior fund analyst at Morningstar, says the fund is invested in distressed debt. Morningstar released a list on Thursday detailing where all of the funds fit into its new classification system. “It really is a junk bond fund or a high-yield bond fund,” says O’Leary.
Since the fund is less than a year old, the duel classification isn’t likely to have much of an impact on it. Still, the dispute illustrates just how advisors and fund managers may have to decide which fund category system they will use.
Classification is for advisors, according to Ralf Hensel, chair of the CIFSC and IFIC’s senior legal counsel.” Advisors have suitability obligations to their clients,” he says. “For them to recommend a particular fund that CIFSC puts in this category but Morningstar puts in a different — and a significantly different — category, then that’s a problem.”
The Chou fund won’t be the only one to move under the Morningstar’s new categories. Two of Canada’s largest dividend funds will no longer be measured against other Canadian dividend-mandated investments. Investors Dividend, Canada’s largest fund, as well as the TD Dividend fund will be placed in the Canadian equity-tilt category, while the majority of the Canadian dividend funds have been placed in the Canadian anchored equity, Canadian equity or Canadian high income equity categories.
On the other hand, the CIFSC puts the Investors fund in the Canadian balanced-equity focus category, and puts the TD offering in the Canadian income-balanced category.
According to O’Leary, these funds have significant bond holdings, which distinguish them from typical dividend funds. In the case of Investors, the fund is so big that they have trouble investing in equity so they’ve invested in bonds. “The truth is it’s probably a benefit for the fund itself to change categories, because those bonds represent a drag on the fund’s performance compared to other Canadian dividend funds that are fully invested in equity, which has been performing very well.”
Even if Morningstar and the CIFSC see funds in the same light, it might send some managers scrambling to modify their holdings in order to meet the new category requirements. Take the Dynamic American Value fund, whose objective, according to Morningstar, is “to provide long-term capital growth primarily by investing in U.S. companies.” Yet, both Morningstar and the CIFSC view it as a North American equity fund, which could force the manager to change the fund’s objective or adjust his portfolio, that is, if he or she doesn’t want the name of the fund to confuse investors.
