The Morningstar Category™ classifications were introduced in 1996 to help investors make meaningful comparisons between mutual funds. Morningstar found that the investment objective listed in a fund’s prospectus often did not adequately explain how the fund actually invested. For example, many funds claimed to be seeking “growth,” but some were investing in established blue-chip companies while others were seeking growth by investing in small-cap companies.
The Morningstar Category classifications solved this problem by breaking portfolios into peer groups based on their holdings. The categories help investors identify the top-performing funds, assess potential risk, and build well-diversified portfolios. Morningstar regularly reviews the category structure and the portfolios within each category to ensure that the system meets the needs of investors.
In the United States, Morningstar supports 47 categories for VA/L subaccounts, which map into three broad asset classes (U.S. Stock, International Stock, and Taxable Bond). The primary and secondary indexes listed with each category are used in Morningstar’s tools and reports to show performance relative to a benchmark.
U.S. Stock Subaccounts
U.S. Stock subaccounts are placed in a category based on the style and size of the stocks they typically own. The style and size parameters are based on the divisions used in the investment style box: Value, Blend, or Growth style and Small, Medium, or Large size (see the Morningstar Style Box definition for more details on style methodology).
By reviewing their investment style over the past three years, we place U.S. Stock subaccounts in one of the following nine categories:
Morningstar also includes several other, specialized categories, including:
Balanced
The primary index for this broad asset class is the Dow Jones Moderate Portfolio Index. This index has exposure to equities (generally around 60%), bonds (generally around 30%), and cash (generally around 10%). It also has exposure to both U.S. and international markets. This new broad asset class will contain the following seven categories:
International Stock Subaccounts
Stock subaccounts with 40% or more of their equity holdings in international stocks (on average over three years) are placed in one of the following international-stock categories:
Fixed-Income Subaccounts
Subaccounts with 70% or more of their assets invested in bonds are classified as fixed-income subaccounts and include:
Finally, the Morningstar Category for VA/L subaccounts includes a Money-Market Category.
Benefit
Morningstar Categories provide a more critical look at a subaccount’s investment approach, and will help financial professionals and investors to select the right combination of subaccounts for their portfolio. Morningstar Categories are also used for defining the Morningstar Rating.
Origin
Morningstar generates this data in house. We calculate category averages on a monthly basis.
For the Pros
Morningstar assigns categories to all types of portfolios, such as mutual funds, variable annuities, and separate accounts. Portfolios are placed in a given category based on their average holdings statistics over the past three years. Morningstar’s editorial team also reviews and approves of all category assignments. If the portfolio is new and has no history, Morningstar estimates where it will fall before giving it a more permanent category assignment. When necessary, Morningstar may change a category assignment based on recent changes to the portfolio.
The driving principles behind the classification system are as follows:
Individual portfolios within a category invest in similar types of securities and therefore share the same risk factors (e.g. style risk, prepayment risk).
Individual portfolios within a category can, in general, be expected to behave more similarly to one another than to portfolios outside the category.
The aggregate performance of different categories differs materially over time.
Categories have enough constituents to form the basis for reasonable peer group comparisons.
The distinctions between categories are meaningful to investors and assist in their pursuit of investing goals.