Morningstar unveils competing fund categories

By Mark Brown | May 26, 2006 | Last updated on May 26, 2006
4 min read

Morningstar Canada has released the first draft of proposed new categories for mutual funds, just days before the Canadian Investment Funds Standard Committee prepares to overhaul its system.

Morningstar left the CIFSC in March, saying the committee was moving too slowly on fundamental questions such as breaking down major fund categories into subsets. CIFSC’s revised fund categories are expected to be announced on Wednesday and will come into effect this July.

CIFSC has been talking about a total revision of its classification scheme since October and has been formally circulating its proposed categories around the industry since February. Since Morningstar was a member of CIFSC during much of this period, it is possible that several of Morningstar’s ideas may parallel the new standard.

Morningstar presented several of its ideas just before it resigned from the CIFSC. “There were a lot of interesting ideas there,” says CIFSC chair Ralf Hensel, but he adds that some of Morningstar’s suggestions were reliant on a proprietary methodology that other data providers on the board couldn’t match.

Morningstar’s new approach would introduce 46 fund categories, not counting 15 proposed hedge fund groupings. The new categories are described in great detail in a discussion paper released on Friday. The hedge fund categories were designed by Morningstar’s head office in the U.S. and added to the Canadian mix, since there is quite a bit of overlap, explains David O’Leary, the senior analyst charged with developing the new categorization system for Morningstar Canada.

All told, Morningstar’s new approach has 29 more categories than the current 34 set by the CIFSC. Most of the new categories are the result of breaking up some of the large CIFSC categories like the Canadian Balanced fund group into more specific elements. (A complete list of the new categories can be found on the next page).

For instance, under the current structure the Canadian Balanced category tracks some 950 funds. Morningstar suggest breaking this down into four groups: tactical asset allocations, an equity tilt, a fixed income tilt and a neutral that is an even split between fixed-income and equities.

“Most of the additions come in really big categories,” says O’Leary.

The changes are designed to eliminate the problem of funds being slotted into the wrong group. Several funds in the Global Balanced category invest basically only in stocks, O’Leary notes, citing RBC-DS Aggressive Growth as an example. “The fund only came out in September 2005 but has never had any exposure to bonds,” he says. “Why isn’t it in the equity category?”

Funds are also currently misclassified by geographic region, he adds. Consider Investors’ Tactical Asset Allocation fund which currently sits in the Global Balanced & Asset Allocation category. In the 12 year history of this fund, the most it has ever held in non-Canadian stocks and bonds is less than 2%. “In the past few years this would be an unfair advantage for the fund since the Canadian markets have dramatically outperformed other world markets,” O’Leary explains.

But will having another set of fund groupings create confusion in the industry?

O’Leary doesn’t think so. “I think the fear of having a multiple categorization system is overblown,” he says. Fund companies fear that the new structure might cause some confusion, but as O’Leary points out, that’s nothing new. IFIC only recently started using CIFSC categories when reporting funds sales and Globefund’s star rating uses its own categories for its star rating system. “The CIFSC is probably the most widely accepted, but there still are multiple categorization standards out there.”

“We agree on the theory,” says Hensel. “I still disagree that it was necessary to have a separate system.” His concern is that this could push Canada towards the U.S. model of comparing funds. As Hensel points out, the United States has three main data providers but there is no standardization of how that data is reported. What ends up happening, he says, is that fund companies choose whichever one makes them look best.

Morningstar is giving industry participants until June 23 to provide feedback on its new categories and plans to roll out the final version later this year.

Asset Class Morningstar Canada Category Name
Money Market Canadian Money Market
US Money Market
Canadian Fixed Income Short Duration
Income Core
Income Long Duration
Income Inflation-Protected
Global Fixed Income Global
High Yield Fixed Income High Yield
Portfolio Income Income Portfolio
Canadian Portfolio Canadian Tactical Asset Allocation
Canadian Equity Tilt
Canadian Neutral
Canadian Fixed Income Tilt
Global Portfolio Global Tactical Asset Allocation
Global Equity Tilt
Global Neutral
Global Fixed Income Tilt
Life Cycle Portfolio 5 Year Target Date
10 Year Target Date
15 Year Target Date
15+ Year Target Date
Equity Income Equity Income
Equity High Income
Domestic Equity Canadian Large Cap
Canadian Small/Mid Cap
Canadian Anchored Large Cap
Canadian Anchored Small/Mid Cap
Foreign Equity North America
US Large Cap
US Small/Mid Cap
Asia Pacific Rim
Asia Pacific Rim ex-Japan
Emerging Markets
Global Large Cap
Global Small/Mid Cap
Sector Equity Financial Services
Natural Resources
Precious Metals
Science & Technology
Real Estate
Specialty Labour Sponsored Investment Fund
Hedge Fund Equity Focus Equity Net Long
Equity Focus Equity Net Neutral
Equity Focus Equity Net Short
Equity Focus Equity Variable
Arbitrage Relative Value Arbitrage
Arbitrage Convertible Arbitrage
Arbitrage Fixed Income Arbitrage
Corporate Life Cycle Corporate Event Driven
Corporate Life Cycle Distressed Companies
Corporate Life Cycle Merger Arbitrage
Macroeconomic Trends Global Macro
Macroeconomic Trends Emerging Markets
Macroeconomic Trends Managed Futures
Combinations Multi Strategy
Combinations Fund of Funds

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Mark Brown