Fixed-Income Style Box

A fixed-income style box provides a visual representation of the investment characteristics of fixed-income investments. Fixed-income style boxes were created by Morningstar and are most commonly used for mutual funds. They are a valuable tool for investors to use in determining the risk-return structures of their fixed-income investments. They also help investors to classify and choose investments based on certain investing criteria.

A fixed-income style box is made up of nine squares with the vertical and horizontal axis used for defining investment characteristics. Morningstar uses interest-rate sensitivity and credit quality as the two primary characteristics for consideration.

On the horizontal axis, investors will find three categories for classifying interest-rate sensitivity: limited, moderate and extensive. Interest-rate sensitivity is affected by a fund’s duration. Therefore, short-term fixed-rate funds will be found in the limited category while long-term fixed-rate funds would fall in the extensive category.

On the vertical axis, credit quality ratings are a second factor used for classifying fixed-income fund investments. Style box credit quality categories include high, medium and low.

Morningstar provides a detailed breakdown of the parameters for style box quadrant classification. Interest rate sensitivity classifications are determined by a fund’s three-year average duration in comparison to the Morningstar Core Bond Index. Credit quality is determined by a methodology involving weighted average credit ratings of a fund. Funds in the high credit quality box will have an asset weighted average credit rating of AA- and higher. Funds in the low credit quality box will have an asset weighted average credit rating of less than BBB-. Morningstar is the primary developer of fixed-income style boxes however variations do exist from other financial information providers.

With rates potentially on the rise in 2018, a fixed-income investor using style box investing to identify fixed-income investments may be interested in filtering for the top performing funds with limited interest rate sensitivity and high credit quality. In the limited / high credit quality box the Franklin Minnesota Tax-Free Income Fund is one of the category’s best performing funds based on one-year performance through January 9, 2018. The Fund has a net asset value of $12.33. Its one-year return is 3.62%. Trailing twelve-month yield for the Fund is 2.89% and its 30-day SEC yield is 1.33%.

Investors seeking higher potential returns from lower credit quality investments with a continued focus on limited interest rate sensitivity would want to filter for limited and low quality. In this style box, the MFS Emerging Markets Debt Local Currency Fund is a top performing fund. The fund has a one-year return of 15.33% with an expense ratio of 1.10%. Its trailing twelve-month yield is 4.25% and its 30-day SEC yield is 3.82%.