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A Better Way to Look at Allocation Funds

We're moving from the three-category conservative-, moderate-, and aggressive-allocation system to an expanded five-category framework for allocation funds. 

Benjamin N. Alpert, CFA and Janet Yang, CFA, 05/02/2016

Morningstar periodically makes changes to the Morningstar Category system, and a number of updates took place at the end of April 2016. These modifications generally occur when we create or retire a category or refine a category definition. Today's article covers the most common questions related to updates to the allocation categories. We'll cover the addition of various equity, fixed income, and alternative investments categories in tomorrow's Fund Spy.

Why does Morningstar change its category system?
We strive to keep our categories relevant for investors and reflect the realities of the investments being used. We incorporate our internal research, academic research, industry trends, and stakeholder feedback into our decision process. Since categories were introduced around 30 years ago, we’ve regularly reviewed our classifications to ensure the assignments provide meaningful insight for investors. We now perform this analysis annually. Currently, we have around 120 categories for the 10,000 registered mutual funds that we classify in the United States. When we first launched categories around 1988, there were only eight.

What's changing for allocation funds?
Our allocation categories generally house funds that offer investors a mix of stocks and bonds, and they include the world-allocation, tactical-allocation, and target-date groups. The biggest change in this area was our move from the three-category conservative-, moderate-, and aggressive-allocation system to an expanded five-category framework. Exhibit 1 summarizes that category system, both before and after the April 2016 updates.



We globally reviewed the landscape for multiasset products and found that a more nuanced framework would better serve investors. Many firms offer more than three risk-tailored multiasset fund strategies, and, in fact, we've seen as many as nine in some multiasset models. After significant review and deliberation, we've concluded that five risk buckets will best serve investors. We evaluated the three-year average holdings and performance of all allocation funds and observed stratification in line with the new five-category allocation system. The change in naming convention--with the equity allocation ranges included in the name of the category--should also provide a clearer indication to investors of why the funds are grouped together within each category.

How much did the funds move among categories as a result of the new allocation framework?
Even though we moved to a five- from a three-category system, changes to funds' categories were relatively marginal. That's because the equity allocation ranges that guided the prior system largely carried over to the new one. For instance, the moderate-allocation category included funds that had 50% to 70% equities, and those funds map directly to the new Allocation 50%-70% Equity group. As a result, traditional 60/40 equity/fixed-income balanced funds saw no category movement.

Some of the more notable changes resulted from funds that were part of a target-risk series moving from equity style box categories into the new Allocation 85%+ Equity category. They include funds such as American Century One Choice Very Aggressive AOVIX and John Hancock Funds Lifestyle II Aggressive JIIOX, which were previously in the large-growth and large-blend equity categories, respectively. More than a dozen distinct funds that were part of a target-risk series moved from these equity style box groups into Allocation 85%+ Equity. The changes also helped make the equity categories relatively more homogeneous and meaningful for performance comparisons.

Benjamin N. Alpert, CFA is a hedge fund analyst at Morningstar.
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