Understanding the Mutual Fund Style Box

Hello there! This is Kyle Jones, Financial Advisor at Wamhoff Financial Planning & Accounting. Today, I wanted to provide some information on how mutual funds are classified, and provide some clarity on how these classifications are reached.

A common research tool used by investors and Financial Advisors is Morningstar. Morningstar has a vast amount of information regarding particular stocks, mutual funds, and other investments.

We are going to take a closer look at the information provided by Morningstar, as it pertains to mutual fund characteristics.

Let’s focus on what is called the Morningstar Style Box. The Morningstar Style box is a graphical representation of a mutual fund’s characteristics. The result is used to evaluate the overall holdings within a particular stock or mutual fund. The style box classifies securities according to market capitalization along the vertical axis, and growth and value factors on the horizontal axis of the grid.

Market capitalization refers to the overall size of a particular company. To be categorized as a large-cap company, the company must fall into the top 70% of the capitalization of the particular region. The companies that fall under this category are the blue-chip companies, that many of us are familiar with. Names such as Boeing, Monsanto, Wells Fargo, Apple, etc. Mid-Cap companies fall into the next 20% of market capitalization, and small-cap companies are the smallest 10%.

There are a number of factors that Morningstar uses to help determine whether a company is more value or growth-oriented, or if it falls somewhere in the middle, which is termed blend or core.

The components and weights when evaluating the value score are as follows:

Forward looking measures such as price/earnings ratios, make up half of the score in relation to value. Historical based measures make up the other half, such as price/book, price/sales, price/cash flow, and the dividend yield.

For the growth evaluation, again, half is based upon forward looking measures, and the other is historical-based. Long-term projected earnings growth is used for the forward looking aspect. Historical earnings growth, sales growth, cash flow growth, and book value growth, are the historical-based measures used to determine a growth score.

These characteristics are compared to other stocks within the same capitalization band, to help determine the overall style score. The scores for both growth and value are scored from 0 to 100. The value score is subtracted from the growth score, to reach a final style figure.

On one end of the spectrum, a score of -100 is a company with a very high-yield, and low growth. Conversely, a score of 100, would be a company with a low-yield, but very growth-oriented.

Value stocks, usually score around -15 and below. Growth stocks, usually have a score around 25 and above. Blended funds, fall between the two thresholds.

You might be wondering how this fits into a mutual fund. Mutual funds hold a number of individual securities, typically with a variety of capitalization levels, and growth and value characteristics. Each security is screened and plotted using the criteria described earlier. The asset-weighted average of the underlying securities’ style and size determines the overall style of the mutual fund. The style box assignments are updated on a monthly basis.

When you are given a factsheet for a particular mutual fund in the future, you will now have a better understanding of the style box, and the criteria which determines the particular style.

Until next time, Happy Investing!