Morningstar unveils competing fund categories

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
	Japan
	Europe
	Emerging Markets
	Global Large Cap
	Global Small/Mid Cap
	International
Sector Equity	Financial Services
	Natural Resources
	Precious Metals
	Science & Technology
	Real Estate
	Healthcare
Specialty	Labour Sponsored Investment Fund
	Specialty
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

Filed by Mark Brown, Advisor.ca, mark.brown@advisor.rogers.com

(05/26/06)

Mark Brown

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