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The Reasoning Behind Our Newest International-Stock Category

You might call it improvement by subtraction.

Gregg Wolper, 07/02/2013

As we do from time to time, Morningstar has created a new international-fund category. The new group, which goes by the catchy name "miscellaneous region," consists mostly, though not exclusively, of single-country funds.

Although creating a new category is a common occurrence at Morningstar as fund companies continually explore different areas of the investment landscape, our reason for carving out this one was somewhat different from the norm.

Giving Them Their Own Home
The primary reason we create new fund categories is to group together similar offerings that have become fairly numerous and popular, so interested investors can more easily find them and compare them with one another. Another reason we take this step is to improve the relevance of these funds' rankings and averages.

For example, by creating the India-equity category in mid-2012, we allowed India funds to be ranked only against other India funds and for the new category's averages to reflect the performance and characteristics of those funds alone. Previously, India funds were ranked not only against each other but also against broader Pacific/Asia ex-Japan stock funds. The same dynamic applied to funds focusing solely on the China region, which were given their own category in 2010.

Taking One for the Team
But there's a third, less obvious reason we add new groupings: to improve the usefulness of existing categories. In the above example, the number of India funds had reached a point where they were skewing the rankings and averages for the Pacific/Asia ex-Japan stock category itself. That category had been set up to represent funds that invest all over the Pacific/Asia region, save for Japan--not for single-country portfolios with much narrower mandates. Removing the India funds (and the China-focused funds before them) improved the Pacific/Asia ex-Japan category.

This goal--making other categories better--almost entirely explains the creation of the miscellaneous-region category. Over the years, fund companies have launched more and more international funds (particularly exchange-traded funds) that don't fit cleanly into any category. Mainly, that owed to such funds' focus on a single country or a small region such as the Nordic nations or Europe's emerging markets.

Unlike the India or China groups, there weren't nearly enough funds focusing on Canada, Indonesia, the Gulf States, or anywhere else to justify creating a new category for funds with any of those mandates. So, they had been placed in categories designed for portfolios with broader geographic exposure.

Having one or a few such funds in a broader category was inconsequential. When the number of ill-fitting funds in a group grows too large, though, the problems outlined above arise, with category averages being distorted and proper analysis rendered more difficult. We did not want to wait for the time when there were enough funds targeting each country or small region to merit separate new categories for all. (We like to see at least 20 funds with a certain mandate before creating a category for them.) Rather, we decided to remove all of these narrow-mandate funds from their current categories now and combine them into one new group.

Admittedly, the resulting miscellaneous-region category does not provide one benefit of most new categories: allowing investors to compare similar funds against one another. But we decided that this shortcoming was a reasonable price to pay for the improvements in so many other categories.

It's not the only category arranged this way. For example, the many intermediate-term municipal-bond funds that invest only in bonds from California are grouped together into their own category, as are those that focus on bonds from the state of New York. But those that concentrate on Arizona, Maryland, or other individual states are gathered together into one big category, labeled "muni single-state intermediate."

Special Considerations
Owing to the heterogeneous nature of the miscellaneous-region category, we decided that the funds in this group will not receive Morningstar ratings (star ratings). Star ratings are determined by comparisons within categories, and it did not seem appropriate for funds with such disparate geographic purviews to be competing against each other for ratings. After all, such ratings would reveal much more about the performance of the various markets than anything about the individual funds themselves.

Returns rankings and portfolio data, however, will be provided. That way, investors who do want to know which markets have been outperforming or how the various Canada funds stack up will have an easy way to see that.

Overall, there are just over 100 mutual funds, ETFs, and closed-end funds in the new group, with the bulk of them being ETFs. Nearly all are devoted to a single country. They include some relatively large, established offerings, such as iShares MSCI Germany Index EWG ($4 billion in assets), iShares MSCI Canada Index EWC ($3.4 billion), and Fidelity Canada FICDX ($2.7 billion), which have histories going back to 1996 (the two iShares funds) and 1987, respectively. But also well represented are newer, smaller entrants, such as Market Vectors Indonesia Small-Cap ETF IDXJ and iShares MSCI Norway Capped Investable Market Index ENOR, which were both launched in 2012 and have less than $15 million in assets apiece.

The inhabitants of the miscellaneous-region category might not reside there forever. Right now, though, no area has near enough funds devoted to it to justify creating another category based on a country or region.

Gregg Wolper is an editorial director and senior mutual-fund analyst at Morningstar.

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