The intermediate-term bond Morningstar Category long ranked as the largest of the fixed-income categories, home to funds that invested primarily in investment-grade fixed-income debt and had durations (a measure of interest-rate sensitivity) that landed in the intermediate-term range. Effective April 30, 2019, we retired the intermediate-term bond category and introduced two new categories: intermediate core bond and intermediate core-plus bond. With a few exceptions, funds that previously landed in the intermediate-term bond category are now assigned to one of these two new categories. The following Q&A provides some background on the changes.
What is the rationale for the changes to the intermediate-term bond category? Funds in the old intermediate-term bond category shared many characteristics. They invested primarily in investment-grade U.S. fixed-income issues, including government, corporate, and securitized debt, and typically had durations that ranged from 75% to 125% of the three-year average effective duration of the Morningstar Core Bond Index.
Despite those commonalities, however, the category included a mix of portfolios that tended to cluster in one of two subgroups. The first contained funds that stuck to U.S.-dollar investment-grade debt with very little exposure to below-investment-grade fare. The second included funds with more-flexible mandates; these typically held larger positions in below-investment-grade debt, with many venturing into emerging-markets debt and non-U.S.-dollar debt and currencies. Funds in these two subgroups tend to behave differently in different market environments and offered investors moderately different risk/reward trade-offs. The change to Morningstar's category schema is designed to provide investors with clearer expectations for risk and performance and to create more homogeneous categories.
What are the definitions for the new categories? The definitions for the two categories are provided below. Note that we have not made any changes to the duration ranges for the categories. Meanwhile, the definition for the multisector bond category, which includes funds that take on more credit risk, remains unchanged.
Intermediate core bond portfolios invest primarily in investment-grade U.S. fixed-income issues, including government, corporate, and securitized debt, and typically hold less than 5% in below-investment-grade exposures. Their durations (a measure of interest-rate sensitivity) typically range between 75% and 125% of the three-year average of the effective duration of the Morningstar Core Bond Index.
Intermediate core-plus bond portfolios invest primarily in investment-grade U.S. fixed-income issues, including government, corporate, and securitized debt, but generally have greater flexibility than core offerings to hold noncore sectors such as corporate high yield, bank loan, emerging-markets debt, and non-U.S. currency exposures. Their durations (a measure of interest-rate sensitivity) typically range between 75% and 125% of the three-year average of the effective duration of the Morningstar Core Bond Index.
How do portfolios in the two categories differ? By definition, funds in the core bond category typically hold less than 5% in below-investment-grade debt, so these funds tend to have credit-quality profiles that skew more heavily to the higher-rated tiers of the market. So, for example, preliminary analysis shows that the median allocation to below-investment-grade debt as of the most recently available survey date stood at close to 0% for core bond funds, while the median allocation for core-plus bond funds was a little over 8%. Meanwhile, core bond funds tended to hold larger allocations to AAA rated debt with a median stake of 62%; core-plus bond funds held less in the highest-rated tier of the market, with a median of a little under 50%. From a sector perspective, core bond funds tended to hold more government-backed debt, while core-plus bond funds were more heavily invested in corporate debt.
The categories look more similar when it comes to duration and interest-rate sensitivity. Based on preliminary data, the most recently reported average effective duration for the intermediate core bond category was about 5.7 years; that's roughly in line with the 5.5-year metric for the intermediate core-plus bond category.
How big are the two categories? Following the split, the core-plus bond category is home to roughly 190 open-end and exchange-traded funds, totaling around $720 billion in total assets; the core bond category spans about 140 funds; assets in this group are roughly $830 billion.
How have funds in the two categories performed over time? Differences between intermediate core and intermediate core-plus bond portfolios are clear in the performance profiles of the two categories. Low- and midrated bonds have outperformed for most of the trailing 10-year period, which began right as credit markets started rebounding off their financial-crisis lows. The 5.0% median annualized return for core-plus bond funds (looking at distinct funds) over that period through March 2019 topped the 3.9% median annualized return for core bond funds. Core bond funds also tend to be more sensitive to moves in bond yields than core-plus bond funds, which can mean bigger gains when yields rally and bigger losses when yields rise. Meanwhile, core bond funds tend to hold up better than core-plus bond funds when corporate credit comes under pressure, as it did in the fourth quarter of 2018. Finally, core bond funds have tended to feature somewhat higher correlations to the Bloomberg Barclays U.S. Aggregate Bond Index than core-plus bond funds over the past five years; core-plus bond funds have tended to be more heavily correlated to broad high-yield and equity indexes.
What is the category placement for some of the largest and highest-profile funds that previously landed in the intermediate-term bond category? The big index funds and ETFs that track the Bloomberg Barclays U.S. Aggregate Bond Index dominate the intermediate core bond category and include Vanguard Total Bond Market Index VBMFX, iShares Core U.S. Aggregate Bond ETF AGG, and Fidelity U.S. Bond Index FUBFX. The largest actively managed funds in the category are American Funds Bond Fund of America ABNDX, JPMorgan Core Bond WOBDX, and T. Rowe Price New Income PRCIX.
The intermediate core-plus bond category is home to many of the largest actively managed funds that previously called the intermediate-term bond category home. This new category includes such behemoths as Metropolitan West Total Return Bond MWTRX, PIMCO Total Return PTTRX, Dodge & Cox Income DODIX, DoubleLine Total Return Bond DBLTX, and PGIM Total Return Bond PDBAX.
Will this result in changes to Morningstar Ratings (Star Ratings)? Yes. Morningstar Ratings will be recalculated for funds based on their new categories based on April month-end data. These will be available May 3.
Will this result in changes to Morningstar Analyst Ratings? No, although we regularly review Analyst Ratings and will continue to assess the ability of funds to beat relevant benchmarks and category norms on a risk-adjusted basis across a full market cycle.