Chicago-based Morningstar, the leading mutual-fund resource for individual investors, is revamping its liquid alternatives categorization methodology. In addition to its current alternative-fund categories of multi- and single-currency, managed futures, market neutral, multialternative, long/short equity, volatility, trading and bear market, Morningstar will be adding the following new categories:
- Option writing
- Long/short credit
Infrastructure, another category of funds considered as alternative by many investors, will be added as a subcategory of Sector Equity. Option writing and long/short credit will be added under the broader Alternative fund grouping.
In speaking with investment managers with funds likely to be in the long/short credit category, the news from Morningstar has been received positively. In fact managers have been pushing for more refinement of the large grouping of funds that currently fall into the Nontraditional Bond category, which is part of the larger Taxable Bond grouping.
Guy Benstead, portfolio manager for the Cedar Ridge Unconstrained Credit Fund (CRUMX/CRUPX), says that the new long/short category will allow investors to better compare apples with apples. “The Nontraditional Bond category in some ways was a victim of its own success, becoming a very large category with too many disparate types of funds and strategies,” noted Benstead in a recent conversation. He went on to state, “I think Morningstar is taking a step in the right direction by creating long/short credit; it should help investors better refine their fund searches and distinguish between like for like strategies.”
These changes will be effective April 29, 2016. More detail on each of the new alternative categories is below.
Option writing funds seek a significant portion of their returns from the collection of premiums for selling options. This includes both call- and put-writing strategies, as well as strategies that target returns from contract premiums, and strategies that seek to generate returns from the volatility risk premium associated with options trading.
- Category Group Index: S&P 500 Total Return USD
- Group Index: CBOE S&P 500 BuyWrite BXM
- Morningstar Index: Morningstar US Market TR USD
Morningstar currently has a Nontraditional Bond category under its Taxable Bond Funds heading. But the new Long/Short Credit category will include funds that seek to profit from changes in the credit conditions of issuers and market segments represented by credit indices. According to Morningstar: “Typically, portfolios purchase bonds, or sell credit default swaps, with the expectation of profiting from narrowing credit spreads; or, the funds sell bonds, or purchase credit default swaps, with the expectation of profiting from the deteriorating credit of the underlying issuer.”
The category will include funds that use credit derivatives to hedge systematic risk of credit markets and/or interest-rate risk.
- Category Group Index: Barclays US Aggregate Bond Total Return USD
- Group Index: Bank of America ML USD LIBOR 3-month CM
- Morningstar Index: Morningstar US Core Bond Total Return USD
To be classified by Morningstar as an infrastructure equity fund, a fund must invest more than 60% of its assets in stocks of companies engaged in “infrastructure activities.” This includes firms in the midstream link of the energy value chain (like most MLPs), and companies involved in waste management, airports, integrated shipping, railroads, trucking, construction, or the utilities sector.
- Category Group Index: MSCI ACWI NR USD
- Group Index: DJ Brookfield Global Infrastructure Total Return USD
- Morningstar Index: Morningstar Global Equity Infrastructure GR USD
For more information on all of the category changes being made by Morningstar, download a pdf copy of the Morningstar notification and/or the updated methodology paper.