Morningstar Canada has rejoined the Canadian Investment Funds Standards Committee, preparing the way for the creation of a single system of mutual fund categories within a few months.

After a revised set of the CIFSC categories is released — expected within weeks — a month-long comment period will allow the fund industry and any other interested parties to have input into the process. Within a month or two, the CIFSC will release a final version of the fund categories. The CIFSC includes representatives from CANNEX Financial Exchanges Canada Ltd., Fundata Canada Inc. and Globe Interactive, a unit of the Globe and Mail.

Unhappy with the CIFSC system, Morningstar last year broke away from the committee and established its own set of fund categories. Among other things, Morningstar complained that the CIFSC was not monitoring categories properly, which allowed for inappropriate fund comparisons, and that it was not moving fast enough to deal with the definition of Canadian equity funds following the removal of the foreign content restrictions. This means that clients have faced the confusing prospect of having a particular fund placed and ranked in different categories, depending on which system is used.

“Our concerns were very clear and unambiguous. The good news was that those concerns were addressed,” says Scott Mackenzie, president of Toronto-based Morningstar Canada, adding that negotiations have been conducted for several months. “We’ve been working hard to get back in.”

“There were comments about the split between Morningstar and CIFSC but most of the comments were encouraging us to resolve the split,” says Chris Adair, chairman of the CIFSC and general manager of Toronto-based Fundata Canada Inc. “We’re glad that we’ve been able to do that. It’s in the best interest of the industry and investors.”

COMPLACENCY

As a founder of the CIFSC, Mackenzie notes that Morningstar’s departure was the result of the complacency that had set in. “It was getting to be an intolerable situation. We’re in the business of providing comparative analytics not only for the industry but also for individuals. We can’t have bond funds in equity fund categories, for instance. But that is what happened.”

The discussions with the CIFSC should result in what Mackenzie describes as “best of breed” fund categories.

Although neither Adair nor Mackenzie will reveal the specifics of the new categories, there’s a discussion of the probable changes in an article by Morningstar.ca investment editor Rudy Luukko on the company’s Web site.

Among other proposed changes, there will not be a CIFSC category devoted specifically to income trusts; the CIFSC will add a new global small-cap and mid-cap category; the CIFSC will add four so-called “target-date” categories similar to those that Morningstar introduced last year; and there will be only one CIFSC category for hedge funds, which will continue to be called alternative strategies. However, it is understood that Morningstar will continue to add an additional level of analysis by dividing this latter category into 15 sub-groups. Luukko declined further comment.

In response to concerns that there were too many fund categories, Adair says there is no specific target for the new set. “We want to have enough categories to reflect the different types of funds, but not too many so that it’s confusing.”

Now that Morningstar is back, Adair adds that “it should be business as usual. The CIFSC will continue to do the kind of work it has done in the past: categorizing funds and producing consistent fund classifications.”

Fund company reaction is generally favourable. “It’s extremely positive that the industry is moving back to a single classification system,” says Jonathan Hartman, vice-president of investment products at RBC Asset Management Inc. in Toronto. “We commend Morningstar and the CIFSC for recognizing that this is something that advisors and the fund industry thought was important.”

“People spend time looking at their investment portfolios, trying to compare apples with apples,” Hartman adds. “When the industry can do it in a more consistent fashion, it’s a heck of a lot easier for advisors and investors to do as well.”

Hartman notes that as the industry evolves, it will be important for the CIFSC to be responsive to industry trends. He points to the proliferation of currency hedging in foreign funds. “Helping advisors understand which funds hedge and which ones don’t would be value-added for investors.”

@page_break@This is the benefit of a single committee, says Hartman, as it will look at products in a consistent fashion: “Experts will look at an industry trend and say, ‘Is this the right time to adjust the categories?’”

But some fund analysts remain unconvinced that the impending new single set of categories will be an improvement.

“I’ll know if they made some progress when I see the results,” says Gordon Pape, Toronto-based publisher of Internet Wealth Builder. “I’m skeptical based on the categories that each of the principals came up with last time. I’m not sure which one was more of a mess. My feeling was that Morningstar was worse. I hope they get it right this time.”

Pape notes, for example, that each year he tracks the cash flow from income funds. Unfortunately, these funds are spread over multiple categories within the CIFSC universe — such as Canadian Income and Equity, Canadian Income Trusts, Global Balanced and Global Equity. “The ordinary investor trying to find an income fund will get very confused,” says Pape.

He adds: “If Morningstar and the CIFSC have reached an agreement, I hope it is going to make sense from an investor’s point of view.”

While Dan Hallett, head of Windsor, Ont.-based fund analysts Dan Hallett & Associates Inc. , says the existence of two sets of categories is not as bad as some have argued, he regards the merger as a positive one: “It’s ideal if everybody works toward a single standard — as long as it’s a good one. That was the problem before, as CIFSC didn’t have a good standard.” He adds that in a number of cases, funds were placed in the wrong categories.

Hallett says the merger indicates that the CIFSC “is committed to making changes more quickly and maintaining a higher standard. These are all good things.” IE