The Bond Style Box Explained

2009 August 27

by Kyle

from → Investing And Investments, Mutual Funds

The bond style box, created by Morningstar, is a 9×9 grid designed to visually represent the investment characteristics a bond mutual fund. Since the bond style box’s two dimensions, credit quality and maturity, determine almost 100% of the risk/return characteristics of a given bond fund, the bond style box is a valuable tool for investors to gauge the investment merit, at a glance, of a given bond fund.

The Bond Style Box

The style box is simple: one axis of the grid represents credit quality (government, investment grade, junk bond) and the other axis represents maturity (short, intermediate, and long).

The bond style box below represents a long-term, investment-grade bond fund.

Avg. Weighted Maturity
Short	Med	Long
			Treasury/ Agency	Quality
			Inv.-Grade Corp
			Below Inv.-Grade

By contrast, the bond fund below is a short-term treasury bond fund.

Avg. Weighted Maturity
Short	Med	Long
			Treasury/ Agency	Quality
			Inv.-Grade Corp
			Below Inv.-Grade

Since the short-term treasury bond fund has a much shorter maturity and higher credit quality, you would expect it to offer lower returns than the long-term, investment-grade corporate bond fund. In general, the top-left square offers the lowest risk, but also the lowest return. As you move down and to the right, you should expect much higher risk and volatility but also higher returns over the long term.

It is recommended that most investors stay inside the four boxes pictured below.

Avg. Weighted Maturity
Short	Med	Long
			Treasury/ Agency	Quality
			Inv.-Grade Corp
			Below Inv.-Grade

By contrast, the bond fund below is a short-term treasury bond fund.

Avg. Weighted Maturity
Short	Med	Long
			Treasury/ Agency	Quality
			Inv.-Grade Corp
			Below Inv.-Grade

While long-term and low-quality bonds may yield higher returns over the long term, it generally isn’t worth the risk. Additionally, since junk bonds and long-term bonds often take on a small amount of equity risk (due to their nature), the diversification benefits of owning long-term junk bonds is relatively low compared to short-term, high-quality bonds.