Morningstar Canada today issued a discussion paper for comment about its proposed new fund categorization system. When implemented, the new categories will replace the existing 34 categories overseen by the Canadian Investment Funds Standards Committee (CIFSC), of which Morningstar was a sponsor firm until earlier this year.

“The new Morningstar Canada Categories represent a significant improvement in terms of our ability to provide useful and meaningful tools for fund measurement and performance analysis,” said Morningstar Canada president and CEO Scott Mackenzie. “Investors and their advisors will be better able to identify the best performing funds within rigorously defined and monitored peer groups, and build better risk-adjusted portfolios.”

The comment period, which will last until June 23, will give industry participants, investors and other interested parties an opportunity to provide feedback about the new categories. “The comment period reflects the company’s commitment to a process of ongoing consultations,” Mackenzie said.

The categorization system was developed by Morningstar Canada’s analyst team, led by senior analyst David O’Leary.

The new categories, along with a comprehensive review and monitoring process, will be implemented this summer. Each month, Morningstar analysts will review the category placements. Fund companies will be notified of any proposed re-assignments and will be given one week to respond to category-change proposals.

While some categories will be similar to the CIFSC categories, the Morningstar system will define peer groups more narrowly. Morningstar’s discussion paper lists 46 proposed categories covering all mutual and segregated funds, plus 15 proposed hedge fund categories.

Morningstar believes that investors are best served by categories that enforce a high degree of mandate purity. This is reflected in the proposed new categories. For example, funds in equity categories must invest at least 90% of their non-cash assets in equities, while those in fixed-income categories must hold at least 90% of their non-cash assets in fixed-income securities.

Funds will be categorized according to their holdings. A three-year holdings analysis will assign a 50% weight to the most recent 12-month period, 30% to the next 12-month period and 20% to the remaining 12-month period.

Quantitative screening for the categories will rely on the Morningstar Canada database, which tracks investment funds on a security-by-security basis.

The proposed categories are divided into six broad asset classes, namely Money Market, Fixed Income, Portfolio, Equity, Specialty and Hedge Fund.