Morningstar to create its own fund categories

Morningstar Canada is withdrawing from the industry association that sets mutual fund categories and will set up its own set of standards, following industry consultation.

In making his decision, Morningstar president Scott Mackenzie called the Canadian Investment Funds Standards Committee “complacent,” arguing that it moves too slowly on fundamental questions on categorizing funds or breaking down major fund categories into subsets to group them better according to description and risk category.

“Take for example, the foreign content rule, which has been dispensed with for some time,” he said. “That creates issues as to how you classify the funds. You have differing opinions. There’s some fund executives who think that Canadian Equity Fund can have as much as 49% foreign stocks in it. Some think they should be pure. The purpose of the committee is to deal with stuff like that. It’s been over a year and there’s still nothing done.”

Mackenzie, who co-founded the association in 1998, said he couldn’t wait any longer. He insisted his decision was not a competitive or predatory move on the part of Morningstar, the market leader for fund rating services in Canada.

“It’s bad for everybody. It’s bad for the investor,” he admits. “But the disservice to investors is already happening. [The current] system is wrong.”

Independent fund analyst and consultant Dan Hallett, president of Windsor, Ont-based Dan Hallett & Associates says he supports Morningstar’s decision, calling the current system “poor.” Citing several glaring inconsistencies from the small cap and high-yield bond fund universes, Hallett said he couldn’t quantify the number of times the current fund categories have frustrated his efforts to provide sharper analysis.

“You’re never going to get perfect categories, but if they can come up with something materially better then I’m for it,” he said.

Still, the move creates problems for advisors, who are now faced with a future with two sets of fund categories — Morningstar’s and everyone else’s — frustrating their ability to compare apples to apples, or in this case, Canadian Equity Funds to Canadian Equity Funds.

“I use [Morningstar] in my own analysis, asset allocation, performance analysis and ultimately fund selection,” says Bruce Cumming, an advisor with Cumming and Cumming Wealth Management, in Oakville, Ont. “But if we could maintain one set of fund categories that would be best for all concerned.”

Kelly Rodgers, who co-founded the committee with Morningstar’s Mackenzie, lamented the loss of a Canadian initiative that had been driven by goodwill between the competitors. “It didn’t occur anywhere else in the world,” said Rodgers, who worked on the CIFSC for eight years.

Meanwhile, advisors like Cumming rue the day when they have to explain the mess to investors. Cumming, an Advisor of the Year Award winner in 2004, said it reminded him of the pointless and expensive multiplicity of regulation in the country. “If the powers that be can’t get together and find some common ground, then shame on them. This is pretty basic stuff.”

Gavin Adamson is a Toronto-based financial writer

(03/29/06)