MAY 2003

Lesson 301

Fund Investment Styles, Part I: Overview

Investing Style Specifics

Style Classifications

Investment Objectives

Fund Investment Styles, Part I: Overview

Investing styles are a way of simplifying the complex for fund investors.

Fund data-providers assign funds to different investment classifications so that fund investors can compare funds to one another and have a basis from which to construct a diversified portfolio.

The growth, value and core or blend designations are the bedrock of most fund classification systems.

Basically, growth fund managers seek out companies with rising sales and earnings. Growth fund managers look to profit from rising stock prices driven by increases in company sales and earnings.

Value fund managers, on the other hand, look for companies that are undervalued by the marketplace. Value fund managers seek to profit from the market's recognition of a previously undervalued company.

In between growth and value is blend or core. The blend style describes fund managers who purchase both growth and value stocks.

In this Lesson, we'll discuss how funds are classified and the limits of fund classifications.

Investing Style Specifics

While growth and value are universal concepts in describing stock fund investment styles, not every fund data provider classifies funds in the same way. As a fund investor, you'll see different data sources used in different places.

For example, one newspaper may use data from Lipper, while another uses data from Standard & Poor's. A web site might use Morningstar or Value Line data.

Although fund classifications aren't something that you need to know inside out, they are important when it comes to understanding which funds are grouped together for comparison purposes.

What is a mid-cap value fund to one data provider might be a multi-cap core fund to another. Since fund companies and analysts frequently compare a fund's performance to its peer group, you should be aware that different fund classification systems exist.

Fund classifications systems are far from perfect because they are so broad. Many funds with somewhat different investing strategies are lumped together in a peer group where their performance is compared and contrasted.

This results in some very dissimilar funds being compared to each other. In this situation, its inevitable that some unfair comparisons will be made, so take a fund's comparison to its peer group with a grain of salt.

Many investors seeking to diversify their portfolios rely on investment style classifications when making portfolio allocation decisions.

If an investor doesn't understand the different classification systems or how funds in the same category can differ from one another, he could unintentionally be taking on more risk than he realizes.

In an effort to diversify their portfolio by spreading risk among different types of assets, investors may choose different funds based on their investment style classifications.

However, a deeper examination of these funds may reveal that many of them share some of the same holdings and aren't as different as they seem. Therefore, the investor may not be as diversified as he believes.

Style Classifications

Morningstar's style-rating system is perhaps the best known of the fund data-trackers and providers. The Morningstar Style Box is made up of nine small boxes.

The top of the box is labeled "style" and divided into three headings: value, blend and growth. The right side of the box is labeled "size" and is also divided into three headings: large, medium and small.

Morningstar uses the style box to assign each fund to a category based on management's investing style and the size of companies selected for the portfolio.

Standard & Poor's employs a similar system to classify funds, also focusing on the growth, blend and value designations, although it doesn't employ a style box like Morningstar does. In a similar fashion, Lipper classifies funds as growth, value or core.

Value Line, uses a more complex classification system. Stock funds are divided into four investment objective categories, which are general equity, specialty equity, international equity and partial equity. From there they are divided into 21 investment objective peer groups.

Investment Objectives

The fund data providers determine a fund's investment style after evaluating a fund's portfolio holdings over a certain period of time. It is an external designation and can change depending on the types of companies held in a portfolio and how large they are.

In contrast to a fund's style, a fund's investment objective is an internal designation stated by the fund in its prospectus to investors.

A fund with growth as its objective may hold value stocks, just as a fund with a value objective can hold growth stocks. Generally, fund data providers list a fund's prospectus investment object in their reports.

While style classification systems offer fund investors a quick and convenient way to categorize funds, they don't tell the whole story.

For example, a fund that holds companies of many sizes that are spread between value and growth may be categorized as a mid-cap value fund.

However, the fund doesn't really focus on mid-stocks, but is classified as mid-cap because of the median market capitalization of the fund. The manager may not be a true or deep value manager but may be somewhat more value-conscious than growth managers.

So this fund isn't really a mid-cap value fund. By examining a fund's investment objective, portfolio and average P/E ratio and portfolio earnings growth rate, you can determine what type of fund it is.

There are many varieties of growth and value styles of investing found in mutual funds, and investors should dig deeper into a fund's investing style and objective before deciding to invest in a particular fund.