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Fixed-Income Survey Guidelines

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Morningstar Methodology Paper October Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means,
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Morningstar Methodology Paper October Morningstar, Inc. All rights reserved. The information in this document is the property of Morningstar, Inc. Reproduction or transcription by any means, in whole or in part, without the prior written consent of Morningstar, Inc., is prohibited. Source of Data The data that drive the fixed income style box is surveyed from fund companies. Morningstar asks fund companies to send the following information on a monthly or quarterly basis for each of their fixed-income and allocation funds. Morningstar recognizes that some fixed income and allocation funds are managed as fund-of-funds. In cases where the entire portfolio is managed in a fund of fund approach, if underlying funds representing more than 50% of the assets have provided fixed income surveys Morningstar will aggregate the underlying fixed income survey data to generate statistics. In cases where the fund manages some assets, but has other assets managed through funds, Morningstar requests that these hybrid funds provide the asset weighted aggregation of the requested survey data. Credit Quality Each fixed-income security and cash instrument in a fund is assigned to one of the following eight categories for credit quality calculations. The percentages for assets in that letter rating level are a percent of all fixed income and cash assets. AAA AA A BBB BB B Below B Not Rated Total Morningstar accepts credit ratings reported by fund companies that have been issued by all Nationally Recognized Statistical Rating Organizations. 1 Additionally, Morningstar accepts foreign credit ratings from widely recognized or registered rating agencies. So-called internal, or manager-derived, alphanumeric credit ratings are not to be included in those categories; bonds not rated by an NRSRO (or equivalent foreign rating agency) are included in the not rated (NR) category. 1 Commission orders granting NRSRO registration: in whole or part, without the prior written consent of Morningstar, Inc., is prohibited. 2 Morningstar requests that ratings provided be mapped to the S&P letter rating classification. The attached appendix includes rating mappings of both long-term and shortterm securities for a number of rating agencies. Morningstar instructs funds to classify bonds according to the Barclays Capital Family of Indices ratings rules when ratings are available from multiple rating agencies. If more than two ratings are available and a median exists, use the median. If more than two ratings exist without a median, use the lower of the two middle ratings. If only two ratings are available, use the lower rating. If only one agency rates a security, that rating can be used. If there is a security with no rating, it is considered NR. Here are some additional details about the calculation for credit quality breakdown: Fixed-income securities and cash should be included in the credit quality calculations. The holdings used for calculation should be a trade-dated list that includes the impact of pending trades. Accrued income should be included in the credit quality calculation as part of the total market value exposure of each security. Morningstar categorizes any fixed-income instrument with less than one year to maturity as a cash equivalent. Cash equivalents should be included in the overall calculation of credit quality. Cash and bank deposits that have a traditional letter rating can be included in the appropriate credit quality category. Cash and bank deposits that do not have traditional letter ratings can be included in the AAA credit quality category for purposes of this survey. If a fund holds futures, or other derivative tools such as swaps or options, that have fixed-income securities as the underlying asset or holds other fixed-income funds as assets, the credit quality that is calculated should include the weighted impact of the underlying assets. in whole or part, without the prior written consent of Morningstar, Inc., is prohibited. 3 Funds may report negative values in credit quality breakdown. Convertible bonds should be included in the calculation. Preferred stock should not be included in the calculation of credit quality. Average Effective Duration Morningstar asks fund companies to calculate and send average effective duration (also known as option-adjusted duration) for each of their fixed-income and allocation funds. We ask for effective duration because the measure gives a better estimate of how the price of bonds with embedded options, which are common in many mutual funds, will change as a result of changes in interest rates. Effective duration takes into account expected mortgage prepayment or the likelihood that embedded options will be exercised if a fund holds futures, other derivative securities, or other funds as assets; the aggregate effective duration should include the weighted impact of those exposures. Standard practice for calculating this data point requires determination of a security's option-adjusted spread, including the use of option models or Monte Carlo simulation, as well as interest-rate scenario testing. Morningstar requests that the fund only report data in this field that have been specifically labeled effective or option-adjusted duration, or data that fund is certain have been calculated in the fashion described. Morningstar categorizes any fixed instrument with less than one year to maturity as cash for the purposes of calculating a fund's asset allocation breakdown. These short-term fixed securities and other cash instruments are included in the calculation of effective duration. Morningstar will accept surveys returned with modified duration (and no effective duration provided) only for funds in the municipal and high-yield categories. Surveys for all other categories that lack a submission for effective duration will not be accepted. in whole or part, without the prior written consent of Morningstar, Inc., is prohibited. 4 Average Effective Maturity Morningstar asks fund companies to calculate and send average effective maturity for each of their fixed-income or allocation funds on a monthly or quarterly basis. Average effective maturity is defined as a weighted average of the maturities of the bonds in a portfolio, taking into account all expected mortgage prepayments, puts, and adjustable coupons. Maturity is defined as the length of time in years until a debt becomes due for payment. If a fund holds futures, other derivatives, or other funds as assets, the average effective maturity should include the weighted impact of the underlying assets. Any fixed instrument with less than one year to maturity should be included in the calculation of average effective maturity. Please do not send average nominal maturity, defined as a measure of a bond's maturity that, unlike average effective maturity, does not take into account expected mortgage prepayments, puts, or adjustable coupons. Shorts and Derivatives Morningstar asks companies to calculate and include the effective economic exposures of fixed-income derivatives within the fixed-income survey. Interest rate derivatives should be included in the estimation of average effective duration. Alternative Minimum Tax Exposure Morningstar asks fund companies to calculate the percentage of each U.S. municipal bond portfolio's bonds whose income distributions are subject to the AMT. So-called private-activity municipal bonds are subject to the AMT. in whole or part, without the prior written consent of Morningstar, Inc., is prohibited. 5 Yield to Maturity Morningstar asks fund companies to calculate an average yield to maturity for the portfolio. The calculation of yield to maturity should take into account the market prices as of the date of the portfolio, par value, coupon interest rate, and time to maturity. All coupons are assumed to be reinvested at the same rate. All Pre-Refunded Morningstar asks fund companies to calculate the percentage of each U.S. municipal bond portfolio's bonds that are pre-refunded. Pre-refunded bonds are bonds that may have originally been issued as revenue or general obligation bonds but are now secured until the call date or maturity in an escrow account consisting entirely of U.S. government obligations that are sufficient for paying the bondholders. Currency Exposure Morningstar asks fund companies to provide information about how each taxable fund's fixedincome and cash assets are distributed among currencies. (Morningstar calculates in-house how each fund's fixed-income and cash assets are distributed among countries.) For example, a world bond fund with broad exposure might show 10 different country exposures. If that fund did no currency hedging whatsoever, its currency exposure would mirror its country exposure. If, however, the same portfolio were fully hedged to the U.S. dollar, the fund's country exposure would remain the same while its U.S. dollar exposure would equal 100%. Funds with partial hedges or active currency bets would likely have multiple listings for currency exposure, and the currency exposure may appear to have no correlation to the country exposure. Funds may report negative values in currency breakdown. in whole or part, without the prior written consent of Morningstar, Inc., is prohibited. 6 Appendix Selected NRSRO Ratings Mapped to Morningstar Morningstar Fixed- S&P Moody's Fitch Egan Jones Income Survey AAA AAA Aaa AAA AAA AA+ Aa1 AA+ AA+ AA A BBB BB B Below B AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ CCC CCC- / CC CC / C Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC DDD/DD/D AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ CCC CCC- CC /C/D in whole or part, without the prior written consent of Morningstar, Inc., is prohibited. 7 Appendix Selected NRSRO Short-Term Issue Credit Ratings Mapped to Morningstar Morningstar Fixed-Income Survey S&P Moody's Moody's MIG/VMIG Fitch Egan Jones AAA A-1+ Prime-1 MIG1 F1+ A-1 AA A-1 MIG2 F1 A-2 A A-2 MIG3 F2 A-3 Prime-2 BBB A-3 Prime-3 MIG4 F3 B-1 BB B-1 B-2 B B-2 Not Prime SG B B-3 Below B B-3 C D C D C D in whole or part, without the prior written consent of Morningstar, Inc., is prohibited. 8
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