Investment types that defy easy categorization

They're not quite stocks, bonds or cash, so our X-ray tools classify them as "Other."

Adam Zoll 19 August, 2013 | 6:00PM

Question: When I use Morningstar's Portfolio X-Ray tool, it tells me how much of my assets are allocated to Canadian, U.S. and international equities, along with bonds and cash, but some assets also show up under "Other"? What sorts of investment types does this cover?

Answer: Some Morningstar.ca users may be surprised to find, while analyzing their portfolios using the   Premium Portfolio X-Ray tool, that a portion of their holdings don't fall neatly under the label of equities, bonds or cash. The fact is that some investment types used by fund managers defy easy classification. These include hybrid securities that have characteristics of both stocks and bonds, as well as investments that derive their value from underlying securities (also known as derivatives) but aren't quite the same as owning the securities outright.

Investment types lumped together under the "Other" label include preferred stocks, convertible bonds and convertible preferred shares, options and warrants. You'll also find the "Other" label used under the Asset Allocation section for specific funds, which can be found by clicking on the fund's Portfolio tab.

To help users better understand some of the investment types classified as "Other," here is a guide.

Preferred stock: This is similar to a bond in that it provides a fixed payout, often at a rate higher than those available from bonds. Preferred stock falls ahead of common stock (but behind bonds) in the capital structure, meaning preferred shareholders take priority over common stockholders when a company allocates its income. (Risks associated with investing in preferred stock are discussed in this article.) Preferred stock is often issued by financial institutions, so funds that invest heavily in the sector may have exposure to it.

Convertible bond: This is a type of corporate bond that may be exchanged for company stock at a specified price. Yields typically are lower than those of a comparable non-convertible bond, but the ability to convert the bond into stock means its value can rise with the share price.

Convertible preferred: This is preferred stock that can be converted to shares of the company's common stock.

Option: This is a type of derivative that affords the holder the right to buy or sell a specified amount of a security at a specified price for a predetermined amount of time. Call options give the holder the right to buy the security, while put options give the holder the right to sell it. Funds looking to gain exposure to equities, indexes or commodities might use options to do so without the expense of buying the assets outright.

Warrant: Similar to call options, a warrant allows the holder to buy stock at a specified price during a set time frame. But unlike options, which are created by investors and typically have time frames set in months, warrants are issued by companies and can have time frames that last for years.

Additionally, in rare cases securities held in a fund's portfolio cannot be identified or classified by Morningstar. These are included under the "Not Classified" label.

Figuring out where "other" assets reside
If you find that your portfolio has a significant percentage of assets labelled as Other, or even if you're just curious as to which of your holdings includes these Other asset types, click on the Holdings Detail link at the top of the Asset Allocation section of the X-Ray Overview, or click on the X-Ray Details tab. You will be taken to a page that shows a breakdown of asset type by fund and should be able to easily identify which funds contain investment types labelled as Other. You can then click on the name of the funds to investigate further if you wish.

Discovering that a fund you own holds 5% or more of its assets in investments that fall under the Other label shouldn't necessarily be cause for alarm. Fund managers widely use derivatives and hybrid investments, such as preferred shares, and these assets can be effective tools in pursuing various investment strategies. Of course, it's always a good idea to read up on how your fund uses these investment types. You can do so here at Morningstar.ca or by taking a look at the fund's prospectus.

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About Author

Adam Zoll

Adam Zoll  Adam Zoll is an assistant site editor with Morningstar.com