Morningstar Changes Fund Classification Categories

Beginning in June, the Domestic Hybrid category – those funds that have at least 20% but no more than 70% of assets in stocks and at least 10% in bonds – will be divided into two new categories:   Conservative Allocation and Moderate Allocation, according to the Morningstar news release.  

Other categories will see content and name changes:

• state-specific municipal bond funds will be grouped by state rather than duration
• all single-state municipal bond funds will be removed from the Muni Short category, which contains both national-focused and state-focused funds.
• funds in the Foreign Stock category (funds that invest primarily in non-US stocks) may now hold up to 20% of assets in the United States
• the World Stock category (funds that invest in both US and non-US securities) will now contain all funds that invest at least 20% of assets in the United States.  Previously, funds with more than 10% of assets in the United States were classified as World Stock.
• multisector bond funds will now have a more exact quantitative framework.   Funds that invest 35% to 65% of assets in bonds that are not rated or that are rated by a major rating agency at the level of BB and below, will be classified in the Multisector Bond category.
• two categories will be renamed for consistency purposes.  International Hybrid will become World Allocation and International Bond will become World Bond.

The new categories include:

• Conservative Allocation: funds that invest in both stocks and bonds and maintain a relatively smaller position in stocks. The funds typically have 20% to 50% of assets in equities and 50% to 80% of assets in fixed income and cash.
• Moderate Allocation: funds that invest in both stocks and bonds and maintain a higher position in stocks.   The funds typically have 50% to 70% of assets in equities and the remainder in fixed income and cash.
• Bear Market: funds that use short positions and derivatives in order to profit from stocks that drop in price.   Because these funds have extensive holdings in shorts or puts, their returns generally move in the opposite direction of the benchmark index.
• Bank Loan: funds that invest primarily in floating-rate bank loans instead of bonds.    In exchange for their credit risk, they offer high interest payments that typically float above a common short-term benchmark.
• High Yield Muni: funds that invest at least 50% of assets in high-income municipal securities that are not rated or that are rated by a major rating agency at the level of BBB (considered speculative in the municipal industry) or below.
• State-specific Munis: municipal bond funds that primarily invest in one state.    These funds must have at least 80% of assets invested in municipal bonds from that state.   Each state-specific muni category includes long, intermediate, and short duration bond funds.

The changes are part of a series of enhancements and additions to the company’s research methodology. Morningstar introduced its new investment Style Box methodology in May 2002; implemented the new Morningstar Rating for mutual funds in June 2002; released the new Morningstar industry sector classifications in September 2002; and launched the Morningstar Ownership Zones in March 2003.

The Morningstar Categories were introduced in 1996 to classify a fund’s investment style based on how it actually invests. Rather than assign a category to a fund based on the objective stated in its prospectus, Morningstar analyzes the fund’s underlying holdings. Funds are placed in a given category based on their average portfolio statistics during the past three years. If the fund is new, Morningstar estimates where it will fall based on the information that is available. When necessary, Morningstar may change a category assignment based on recent changes to the portfolio.

For more information about the category changes, go to  http://news.morningstar.com/pdfs/OneSheetNewCategory.pdf .