If you know what you want to achieve, you can probably find a fund that shares that goal.
Every mutual fund has an investment objective, which it describes in its prospectus. The fund’s name often reflects the objective — for example, a fund that seeks a balance of growth and income might call itself the ABC Growth and Income Fund.
Most fund objectives are designed to provide a particular type of return, sometimes within a specific time frame. As a result, the fund objective has a major impact on the types of securities that dominate the fund’s portfolio.
Explicit fund names are also good indicators of how the fund invests. That’s largely because SEC rules require that any fund whose name suggests a certain type of investment must commit at least 80% of its assets to those securities.
Market capitalization matters
Some equity funds concentrate on stocks issued by companies of a specific size, based on their market capitalization, or market cap. Market cap is figured by multiplying the company’s current price per share by the number of floating shares. Those are company shares available for trading.
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Companies are generally divided into three sizes — large cap, mid cap, and small cap — and so are the funds that invest primarily in one of these groups.
* Large caps are companies with capitalizations greater than $5 billion.
* Mid caps are companies valued between $1.5 billion and $5 billion.
* Small caps are companies valued at less than $1.5 billion.
A fourth category, called micro caps, are even smaller companies. Some funds are multi caps, which means they invest in companies of different sizes. Size typically affects the way an investment behaves as market conditions change. In general, though not in every case, the smaller the market cap, the greater the risk to your principal, or amount invested, and the greater the potential for a substantial return.
ELEMENTS OF STYLE
A conservative style focuses on preserving principal by avoiding risk to principal. A moderate style tries to balance capital preservation with taking risks that may result in a greater return. An aggressive style takes bigger risks in pursuit of potentially even bigger returns.
Why bond funds are different?
Bond funds, in contrast, tend to differentiate their investments based on issuer, rating, or term. Here, too, the name of the fund is generally a good indicator of the way it invests. For example, a high-yield bond fund seeking the highest possible current income will concentrate on the lowest-rated bonds that meet its criteria. Similarly, a tax-free income fund will concentrate on municipal bonds, perhaps from a single state. And a fund whose objective is long-term income will buy high-rated corporate or Treasury issues, or both.
Each fund’s manager follows an investing style to help the fund meet its objective.
One approach is to buy securities that are selling for less than the manager believes they’re worth. That’s called value investing, and the assumption is that because the securities are undervalued, the price will rebound.
A contrasting style, which applies more directly to equities than to debt, is growth investing. Growth managers focus on stocks they think will increase substantially in price and have the potential to provide greater returns than the market as a whole. But these stocks also carry greater risk because their prices tend to be volatile.
Blend investing, sometimes called core investing, is a combination of these approaches, where the fund manager tries to find the right balance of undervalued investments and those with strong growth potential.
Contrarian investing, on the other hand, means buying securities that other managers are shunning. Differences in style help explain why funds with the same investment objective may produce different results, both in the short term and over longer periods. Under some market conditions, for example, value stocks may provide much stronger returns than growth stocks do, while the reverse may be true under different conditions. As a result, managers following a particular style may have some strong years and some lean ones.
Style in a box
A stylebox is visual shorthand for categorizing individual mutual funds by market cap and investment style. It’s designed to help investors pinpoint a fund’s basic characteristics, such as the large-cap value fund highlighted here, and pinpoint its risk/return profile. The nine-category stylebox was originally developed by Morningstar as an asset allocation tool.
A sophisticated, computer-based approach to evaluating fund performance, called style analysis, seeks to identify a fund’s underlying investment style based on the way in which its returns correlate with a variety of style indexes such as those tracking growth, value, or income.
You expect a fund to invest in a certain way based on its objective and style. But sometimes, to compensate for weak performance in its primary investment category, a fund’s managers may decide to alter the investment mix to improve return. That style drift could create an imbalance in your portfolio, exposing you unwittingly to greater or less risk than you prefer.
Mutual Fund Objective and Style by Inna Rosputnia
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