Morningstar's fixed-income style box offers a quick visual summary of a given fund's portfolio, offering insight into interest rate sensitivity and credit risk.
Most of us wouldn't buy a new home just because it looked good from the outside. We would do a thorough walk-through first. We'd examine the furnace, check for a leaky roof, and look for cracks in the foundation.
Mutual fund investing requires the same careful investigation. You need to give a fund more than a surface-level once-over before investing in it. Knowing that the fund has been a good performer in the past isn't enough to warrant risking your money. You need to understand what's inside its portfolio--or how it invests. You must find out what a fund owns to know if it's right for you.
The assets in a fund's portfolio are so important that Morningstar analysts spend a lot of their time on the subject. Our analysts examine fund portfolios, talk with the managers about their strategies in picking those holdings, and check on recent changes to the portfolio. Knowing what a fund owns helps you understand its past behavior, set realistic expectations for what it might do in the future, and figure out how it will work with the other investments you might own.
At the most basic level, a fund can own stocks, bonds, cash (usually money market securities), or a combination of the three. If a fund invests in bonds, it could focus only on those issued by the government and companies with rock-solid finances and a high probability that they'll make good on their debts. Or it could venture into higher-yielding bonds issued by firms with shaky future prospects.
How a manager chooses to invest your money has a big impact on performance. For example, if your manager devotes much of the portfolio to a single volatile area, such as low-quality bonds, your fund may generate high returns at times, but there's also a greater likelihood that you'll lose money at other times.
Understanding the Bond-Fund Style Box
The Morningstar Style Box provides a quick visual summary of a given fund's portfolio, using a nine-box investment-style grid to show you where most of your fund's portfolio is invested. For bond funds, the style box focuses on the two key determinants of bond-fund behavior: a fund's sensitivity to changes in interest rates and the credit quality of the bonds in which it invests. Those two factors form the axes of the bond-fund style box. Once we have determined the interest-rate sensitivity and credit-quality coordinates for a bond fund, we use our nine-square style box grid to show investors--visually--where their fund lands. We update each fund's style-box placement every time we receive new portfolio data from the fund company, so the style box also helps investors keep track of whether a fund has changed its approach.
Whereas the stock style box has a growth/value axis and a small/large axis, the two axes of the bond style box are interest-rate sensitivity (or "duration," which we'll discuss in a moment) and credit quality. Interest rate sensitivity is plotted on the horizontal axis as limited, moderate, and extensive, while credit quality is plotted on the vertical axis as low, medium, and high. We arrive at a bond portfolio's style by measuring the average weighted characteristics of the portfolio. ("Average weighted" means that our calculation gives greater weight to a portfolio's big positions than its small ones.)