Morningstar comes up with 72 – count 'em – 72 bond sectors in rating revamp

Morningstar Inc. launched a new fixed-income sector methodology today to give investors a more detailed look at bond mutual fund and ETF holdings. “It's a reflection of the boom in bond funds,” said John Rekenthaler, vice president of research for Morningstar. “Bond funds were clearly playing second banana to stock funds before 2008, but their competitive returns since then have lead to the rise of the bond fund…now they're on equal footing,” he said. More than $330 billion of new money has flowed into taxable bond funds since the beginning of 2010, while investors have pulled out $127 billion from U.S. stock funds, for example. The new methodology places fixed-income securities into one of six “supersectors, and from there into one of 17 primary sectors. Finally, the holdings are placed in one of the 72 secondary sectors. The previous fixed-income fund research simply broke the securities down into one of 13 sectors. “Certainly having more details is going to be helpful to investors,” said Oliver Pursche, president of Gary Goldberg Financial Services. It's particularly beneficial when it comes to fixed income, he added. “Five years ago, the risks of fixed income were perceived to be small, but we've learned a lot over the past four or five years,” Mr. Pursche said. The six supersectors are government, municipal, corporate, securitized, cash and other. The “other” supersector includes a fund's derivatives holdings, such as swaps and options contracts. The primary sectors are more specific, including categories such as bank loans, convertibles, tax-exempt municipals and asset-backed securities. The secondary sectors are particularly granular. Corporate bonds are classified by their sectors, such as financials or technology. Municipal bond funds get the sector treatment as well, with education, transportation and industrials among the classifications. The secondary sectors could pose a challenge for retail investors, Mr. Pursche said. “For professional investors, it's going to be welcome, but the risk for retail investors is they could get too caught up in the minutiae of the breakdowns and fail to make an investment decision because of it,” he said. Rekenthaler agreed it there could be an information overload for some retail investors, but the new system was designed to add depth and make it simpler to understand, he said. To make it simpler for investors, the six super sectors will be prominently displayed in bold, while the primary sectors will be less prominent. The secondary sectors will be available to investors, but only on certain graphics, he said. The new breakdown is available on all fixed-income fund and ETFs as well as asset allocation funds with significant fixed-income exposure.