Mutual Fund Style Defined and Explained
What is Mutual Fund Style and Why Does it Matter?
There's more to mutual fund style than fashion. It is a basic description of how it invests. When distinguishing between the basic types of funds, the mutual fund style generally refers to the stock investing objectives of value or growth in combination with the average market capitalization of the fund's portfolio holdings.
Mutual Fund Style: Market Capitalization - Stocks
Stock funds are first categorized by style in terms of the average market capitalization (size of a business or corporation equal to the share price times the number of outstanding shares):
- Large-cap Stock Funds invest in stocks of corporations with large market capitalization, usually higher than $10 billion. These companies are so large that you have probably heard of them or you may even purchase goods or services from them on a regular basis. Some large-cap stock names include Apple (AAPL), Amazon (AMZN), and Microsoft (MSFT).
- Mid-cap Stock Funds invest in stocks of corporations of mid-size capitalization, usually between $2 billion and $10 billion.Many of the names of the corporations you may recognize, such as Tesla (TSLA) and T-Mobile (TMUS), but others that may not be common household names.
- Small-cap Stock Funds invest in stocks of corporations of small-size capitalization, usually between $500 million and $2 billion. Smaller capitalizations are referred to as "micro-cap" stocks.
Mutual Fund Style: Investment Objective - Stocks
Stock funds are next categorized according to their objective, which will primarily be divided into Growth, Value or Blend objectives:
- Growth Stock Funds invest in growth stocks, which are stocks of companies that are expected to grow at a rate faster than the market average.
- Value Stock Funds invest in value stocks, which are stocks of companies that an investor or mutual fund manager believe to be selling at a price lower than the market value. Value Stock Funds are often called Dividend Mutual Funds because value stocks commonly pay dividends to investors, whereas the typical growth stock does not pay dividends to the investor because the corporation reinvests dividends to further grow the corporation.
- Blend Stock Funds invest in a blend of growth and value stocks.
Mutual Fund Style: Bond Fund Maturity
Bond fund style is broken into two primary categories - Maturity and Credit Quality:
Also expressed as a bond's duration, the maturity can be thought of as an amount of time, which can be loosely and simply translated to mean the number of years of the bond's term. A mutual fund can hold dozens or hundreds of bonds and the maturity is usually expressed as the average duration of the bonds held in the mutual fund.
- Short-term Bond funds primarily invest in bonds that have maturities of less than 4 years. A subcategory of short-term bond funds is Ultra Short-term Bond funds, which will typically invest in bonds with maturities of less than one year. Conservative investors tend to like short-term bond funds because they have lower interest rate sensitivity. However, short-term bond funds have lower relative average returns over time than intermediate and long-term bond funds.
- Intermediate-term Bond funds primarily invest in bonds that have maturities averaging between 4 and 10 years. These bond funds offer a combination of reasonable returns for reasonable interest rate risk, which is why many investors like this basic category of bonds: Economic conditions are difficult to predict. Therefore an investor may "ride the fence" of risk by investing in intermediate-term bond funds. If, for example, interest rates go up, bond prices will go down. The longer the maturity or duration, the more bond prices will fluctuate (in opposite direction of interest rates). Short-term bond funds will perform better in rising interest rate environments but long-term bond funds will perform better in falling interest rate environments. Intermediate-term bond funds find an acceptable middle ground.
- Long-term Bond funds primarily invest in bonds that have maturities longer than 10 years. Therefore these bond funds have greater interest rate risk. When interest rates are expected to fall, long-term bonds are an investor's best bet for higher relative returns compared to short and intermediate-term bond funds. The opposite is true in rising interest rate environments (long-term bond prices will fall faster compared to shorter maturities and will likely cause negative returns for a long-term bond fund investor).
Mutual Fund Style: Bond Fund Credit Quality
This broad categorization reflects the underlying issuer's ability to repay the bond investors. You can think of credit quality as a company's or country's credit score. The score is expressed as a rating, which is generated by a ratings agency, such as Standard & Poor's, on a scale of 'AAA' for the highest credit quality down to 'D' for default. Low credit-quality bonds are usually identified as High Yield or "Junk" bonds because of the greater risk of default (and therefore higher yields to compensate bond investors for the associated risk involved).
See Also: Morningstar Style Box