Financial advisors and their clients will soon have a single set of investment fund categories once again that they can use to rank and compare funds.

The new system will be a welcome alternative to the confusing dual system the industry has been living with for the past several months, with fund categorization schemes offered by both Morningstar Canada and the Canadian Investment Funds Standards Committee, both based in Toronto.

With Morningstar now back in the CIFSC fold after resigning more than a year ago to set up its own competing system, the CIFSC recently released and updated its fund categories, and is inviting public review and comment until May 11. It expects to release the final version of the categories by early June.

“The new regime is the best of both worlds,” says Chris Adair, chairman of the CIFSC and general manager of Toronto-based FundData Canada Inc. “We have set out to establish the best new set of categories, using the two existing systems as a starting point. The new system reflects the industry as it is today, and we hope and expect these category definitions will be stable.”

Industry participants are happy that the confusing situation of having two categorization systems has come to an end. Rankings and classification of funds affects a variety of things, from investor demand for the funds to marketing, manager compensation and asset-allocation decisions. With the two competing systems, a particular fund might have been ranked top quartile within a specific category by Morningstar’s system — but not by CIFSC — because of different parameters for defining the membership of the category.

“The latest categorization scheme is largely a compromise to the Morningstar view,” says Frank Hracs, a fund industry analyst in Toronto. “It’s always been preferable to have one system, and it seems that cooler, logical heads prevailed, and put the schism in the past.”

The CIFSC is a volunteer body, made up of representatives from a variety of Toronto-based organizations with links to the fund industry, including the Canadian Life and Health Insurance Association, Cannex Financial Exchanges Ltd., FP Datagroup, FundData, FundServ Inc., the Globe and Mail, the Investment Funds Institute of Canada, Lipper Inc. and Morningstar.

When Morningstar reps left the CIFSC a year ago, it was to create what they viewed as a superior and more rigorously monitored categorization scheme. Morningstar subsequently introduced an upgraded system of 44 fund categories, plus an additional 15 categories for hedge funds. Meanwhile, in August, the CIFSC came up with its own revised system of categories, adding four to its original list, for a total of 38. Discussions have been ongoing for the past year about whether Morningstar could be convinced to return to the CIFSC fold, as there was a lot of murmuring in the industry about the desire for a single set of categories.

“We are happy the split is over and we are back together working as one group,” Adair says. “It’s in the best interest of the fund industry.”

The latest system has 44 categories. It has many similarities to the Morningstar system, but gives new names to the balanced categories that more accurately describe the fund contents. It also has only one category for hedge funds rather than the 15 that existed under the previous Morningstar regime.

“We’ve been in discussions practically since we left the CIFSC and our return required that a lot of conditions be met regarding process and the rigour of monitoring funds in a proper fashion,” says Morningstar Canada president Scott Mackenzie. “Clearly, that has improved dramatically. What we now have is a ‘best of breed’ in terms of the categories, and a single set that everyone can be happy with.”

Mackenzie says another key function of the CIFSC is independence, and while trade groups such as IFIC will continue to be part of the committee, their influence will be restricted by not having voting power.

Like the Morningstar system, the new CIFSC classification regime does not include a separate category for income trust funds, and Adair says it’s likely that most will end up in the Canadian dividend and income equity category. Reflecting the elimination of the foreign content rule, there are two Canadian stock fund categories: Canadian focused equity, which requires funds to have at least 50% of assets in Canadian equities; and Canadian equity, which requires 90% Canadian equities. The previous Canadian equity pure category is gone.

Fund portfolios will be reviewed on a quarterly basis to make sure their holdings continue to qualify them for the appropriate category. The CIFSC will review each fund’s stated mandate, its historical investment behaviour and risk/return behaviour.

In the balanced category, there are seven subgroups, including Canadian equity balanced, Canadian neutral balanced, Canadian fixed-income balanced, global equity balanced, global neutral balanced, global fixed-income balanced and tactical balanced. Both the Canadian and global equity balanced categories must have between 55% and 90% of assets in equities. Neutral balanced must have between 45% and 55% of assets in equities and fixed-income balanced must have between 55% and 90% of assets in fixed-income securities. All Canadian balanced funds must have 75% of their assets in Canada, while global balanced funds must have 75% of assets outside the country.

There are also four target date portfolios, for balanced funds that have predetermined maturity dates and a mandate to adjust their asset allocation as they approach maturity.

Upon maturity, the funds will be moved to the appropriate fixed income or balanced category. IE