In 2004, Morningstar introduced new portfolio statistics to illustrate the sectors in which a bond investment's assets are invested. The fixed-income securities in a investment's portfolio are mapped into one of 14 sectors, which in turn roll up to five super sectors. These new sectors will help investors and investment professionals easily compare and understand the sector exposure of each investment. This data is especially useful for comparing two investments that may be in the same Morningstar Category.
Super Sectors and Sectors
US GOVERNMENT
US Treasury: This sector includes all conventional fixed-rate debt issued by the US government’s treasury (i.e. it excludes TIPS). Some examples of government debt are Treasury bonds and Treasury notes. Treasury bills are included under % Cash, because they mature in less than 12 months.
TIPS: TIPS are inflation-indexed Treasuries. (The term TIPS derives from their former name, “Treasury Inflation-Protected Securities.”) These bonds have principal and coupon payments that are linked to movements in the Consumer Price Index. They are a defensive measure against expectations of inflation (which typically erodes the real yield of conventional bonds). Even if inflation fears are in check, these bonds can benefit when the yields fall on traditional Treasuries. These unique securities act very differently than any other fixed-rate bond and their volatility can change over time, depending on the level of interest rates.
US Agency: This sector includes the fixed-income securities that are issued by government agencies, such as the Federal National Mortgage Association (FNMA, Fannie Mae) or the Federal Home Loan Mortgage Corporation (FHLMC, Freddie Mac), to raise capital and finance their operations. These “debentures” are not secured by physical assets, so they differ from most of the mortgage bonds that are issued by these agencies.
MORTGAGE
Mortgage Pass-thru: These bonds represent a claim to the cash flows associated with a pool of mortgages. The bondholders are entitled to a share of the principal and interest payments paid by the homeowners. The majority of these bonds are issued by a government agency like FNMA, GNMA, or FHLMC. A few private corporations and banks also securitize and package mortgages in this way and those are also included in this sector.
Mortgage CMO: CMOs are collateralized mortgage obligations. They are similar to pass-thru mortgage securities, but investors have more control over whether they will be paid sooner or later. CMOs are structured by time, so that some investors can line-up for the first series of cash flow payments, while others may choose to put themselves at the end of the line. A fund manager would buy a late-paying CMO if they believed that there would be a lot of mortgage refinancing in the near-term. This would protect the fund from getting money back too early (as cash, which would need to be reinvested at a lower interest rate). Most CMOs are based on mortgages from government agencies, such as FNMA and GNMA.
Mortgage ARM: ARMs are adjustable rate mortgages. These are fixed-income securities that are backed by residential home mortgages, where the interest rate is reset periodically in relation to a benchmark. Most ARMs are from government agencies, such as FNMA and GNMA.
CREDIT
US Corporate: This sector includes all fixed-income securities that are issued by corporations domiciled in the United States. Corporate bonds are issued with a wide range of coupon rates and maturity dates.
Asset-backed: Asset-backed securities are based on the expected cash flow from such things as auto loans, credit card receivables, and computer leases. The cash flows for asset-backed securities can be fixed (e.g. auto loans have a defined payment schedule and a fixed maturity) or variable (credit card debt is paid at random intervals). These securities typically range in maturity from 2-7 years.
Convertible: Convertible bonds give the owner an opportunity to convert the bond to a certain number of shares of common stock at a certain price. As the stock approaches that price, the option to convert becomes more valuable and the price of the convertible bond also rises. These securities usually provide lower interest payments, because the option to convert to stock could potentially be quite valuable at some point in the future.
Municipal: Local and state governments issue municipal bonds in order to raise money for operations and development. This financing is sometimes used to build or upgrade hospitals, sewer systems, schools, housing, stadiums, or industrial complexes. Some municipal bonds are backed by the issuing entity while others are linked to a revenue stream, such as from a tollway or a utility. Municipal bonds are exempt from federal tax and often from state and local taxes, too. The tax break allows municipal governments to sell the bonds at a lower interest rate, because the investor gets an additional tax benefit.
Inflation-Protected: Inflation-protected securities are similar to TIPS, but they are issued by a private entity instead of the US government. These bonds are linked to an index of inflation, and the principal and coupon payments increase when inflation increases. As with TIPS, these securities behave quite uniquely compared to other conventional bonds.
NON-US
Non-US Corporate: These securities are issued by corporations that are based outside of the United States.
Non-US Government: These fixed-income securities are issued by governments outside the United States.
CASH
Cash: Cash can be cash in the bank, certificates of deposit, currency, or money market holdings. Cash can also be any fixed-income securities that mature in less than 12 months. Cash also includes commercial paper and any repurchase agreements held by the fund. Because this data point is based only on the cash and bond assets in the fund, it can be different than the % Cash in the composition breakdown, which is expressed as a percent of total assets.
Calculation
This is calculated for all domestic taxable-bond portfolios, including allocation funds but excluding municipal and international-bond funds. It is based on the securities in the most recent portfolio. This statistic shows the percentage of bond and cash assets invested in each of the 14 fixed-income sectors or the five fixed-income super sectors.