Bond Mutual Fund & ETF CategoriesJune 4th, 2012 by David Waring
Morningstar is a company well-known for its ratings of mutual funds and ETFs. Based on a variety of factors including investment performance and consistency of returns, Morningstar will rate a mutual fund or ETF from 0 to 5 stars. However, comparing funds with different objectives is difficult. How does one compare a stock fund to a bond fund? The short answer is one does not. Instead, Morningstar rates mutual funds and ETFs in relation to similar mutual funds and ETFs.
Morningstar has developed a number of categories for funds with similar objectives or types of investments. With bonds, most categories have two defining characteristics: 1) Types of bonds in the Fund and 2) Maturities of the bonds held by the fund.
Types of Bonds:
Corporate – When a bond fund is in a category such as “Short-term”, “Intermediate-term” or “Long-term” without further description, the bond fund will primarily focus on investment grade corporate bonds. The income from these funds are generally taxable.
Municipal – These funds hold municipal bonds. The income is generally federally tax-free. There are many municipal bond funds which own bonds issued within one state exclusively. Residents of those states will receive income which is also free of state and local taxes.
High-Yield – High Yield Bond Funds hold non-investment grade or unrated bonds which generally pay a higher interest rate, but also have a higher rate of default. The bonds held by High Yield Bond Funds are also referred to as Junk Bonds.
Convertibles – These funds hold preferred stock or corporate bonds that can that can be converted into stock under certain conditions. Typically, these funds are designed for bond investors that believe the stock market is going to rise.
Inflation-Protected – These funds primarily hold Treasury Inflation Protected Securities (TIPS). You can learn more about TIPS here.
Bank Loan - These funds invest in bank loans with interest rates that are tied to short-term interest rates, but pay a higher interest rate.
Emerging Market – Emerging Market Funds have at least 65% of their investments in bonds from emerging market countries, such as Brazil, Russia, India and China.
World – These funds have at least 40% of their investments in bonds from countries other than the United States.
Multisector – As the name implies, these funds have more investment freedom than the typical funds to invest in multiple sectors of the market.
Ultrashort – Average effective maturity of bonds in the fund is less than 1 year.
Short-term – Average effective maturity of bonds in the fund is more than one year and less than 4 years.
Intermediate-term – Average effective maturity of bonds in fund is more than 4 years and less than 10 years.
Long-term – Average effective maturity of bonds in the fund is more than 10 years.
Many bond funds will use the term duration rather than maturity. The duration number is shorter than the average effective maturity. You can learn more about duration here.
Interested in learning more about bond mutual funds and ETFs? Visit the Bond Funds section of Learn Bonds.