The Morningstar Style Box Explained
Morningstar is an independent investment research company known for its style box, which describes the investment characteristics of stocks and mutual funds. The style box can help investors choose securities that are in line with their personal investment objectives.
Although its structure is simple, the Morningstar Style Box contains a wealth of information for new and seasoned investors. Take a look at how the style box works and decide how to use it to make smarter investment choices.
Box Structure
The Morningstar Style Box has the same structure for stocks and mutual funds — both have vertical and horizontal axes that contain three boxes each to form a nine-box grid. The specific labels for the vertical and horizontal axes vary depending on the type of investment being analyzed and the investment’s location in the box is based on the firm’s proprietary calculations.
The fixed-income style box, shown here, is labeled “interest-rate sensitivity” on the horizontal axis and “credit quality” on the vertical axis with groupings: limited, moderate and extensive and high, medium and low, respectively.
According to the Morningstar website, “These groupings display a portfolio’s effective duration and third party credit ratings to provide an overall representation of the fund’s risk orientation given the sensitivity to interest rate and credit rating of bonds in the portfolio.”
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Stocks and Stock Funds in the Box
When using the style box to evaluate stock funds, the horizontal axis represents a stock investment’s growth and value characteristics. Morningstar uses a formula that assigns a score between zero and 100 to each stock.
A score of 100, for example, reflects a high-growth stock that goes in the right column of the box. A score of zero represents an extreme value stock, which is placed in the left column of the box. A stock that falls between these extremes would fall into the “core” category and be located in the middle column of the box.
The vertical axis’s determining factor is the size, or market capitalization, of an individual company. Large companies — those that make up the top 70 percent of market capitalization — appear on the top row. Mid-cap stocks — those that fall in the next 20 percent of market cap — occupy the center row and small stocks appear in the bottom row.
Morningstar uses the same process for stock mutual funds. Each fund is categorized according to the asset-weighted average of its individual stocks.
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Bond Funds in the Box
As shown in the image, the Morningstar Style Box focuses on interest rate sensitivity and credit quality for bond funds. The vertical axis reflects a bond fund’s credit quality.
High credit-quality bonds occupy the top row, low the bottom and medium the middle. Morningstar assigns funds with an average credit quality below BBB- to the low tier and those with an asset-weighted average rating of AA- or higher to the high tier. Funds that fall between these two extremes go into the medium category.
The horizontal axis of the style box focuses on bond funds’ interest-rate sensitivity and features three box categories: limited, moderate and extensive. Morningstar uses a complicated duration formula to determine how sensitive bond funds are to changes in interest rates.
For example, a limited interest-rate sensitivity fund must have less than 75 percent of the Morningstar Core Bond Index’s three-year average effective duration. An extensive interest-rate sensitivity fund must have more than 125 percent of the MCBI’s three-year average effective. Moderately sensitive funds fall in the moderate category.
Find Out: How to Choose the Best Bonds for Your Financial Plan
Benefits of the Box
The Morningstar Style Box is straightforward and easy to understand. Although the mathematics behind it can be complicated, the actual box describes the investment characteristics of a particular stock or fund at-a-glance. If you want to diversify your portfolio, this type of stock and mutual fund analysis can be immensely helpful.
Additionally, the Morningstar Style Box is often a more accurate representation of what a fund holds than the fund advertises. For example, a mutual fund might describe its holdings as “large-cap growth,” but the style box could suggest that it’s really a “large core” fund, based on Morningstar’s analysis of the actual portfolio’s stocks.
The style box receives regular updates, which is essential for investors. Morningstar updates the style box every month for individual stocks and whenever updated portfolio information becomes available for funds.
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Laira Martin contributed to the reporting for this article.
