Most mutual fund names are very simple and easy to understand. For example, many investors recognize that most mutual funds with "small-cap value" in their title invest in smaller companies that fund managers believe to be inexpensive. For the most part, the standard names that describe an investment style, like small-cap value and large-cap growth, accurately describe a fund's investment strategy. It's the more generic and/or vague names that can be much more confusing for the average investor. Read on to find out why.

Tutorial: Choosing Quality Mutual Funds

Equity Income Versus Growth and Income
Equity income or growth and income - what's the difference? Not much, at least by the implication of the fund name.

  • Typically, equity-income funds invest mainly (but not exclusively) in large-cap stocks that pay high dividends, often coupled with some sort of fixed-income asset exposure. They tend to be more value oriented.
  • Growth-and-income funds are not far off, also aiming to provide both growth and income by investing in companies poised for earnings growth and also paying some dividends. These funds tend to be more of a blend and sometimes more geared toward growth as opposed to value.

A simple screen in the Morningstar database would serve as fair evidence. Using the Morningstar style box as a filter, Figure 1 shows how these funds are mapped out within the style box. (To learn more, check out Understanding The Style Box.)

Figure 1
Source: Morningstar

Investors seeking both current income and moderate capital appreciation, such as retirees, would be well suited to owning either type of fund.

Large-Cap Versus Small-Cap Investing
Some mutual fund names are not very detailed, so screening for funds based merely on their investing style does not always reveal the fund's exposure to market capitalization. For example, growth funds or value funds can invest in large or small companies. Let's take a look at Figure 2 as a case study. By taking a deeper look at the fund's underlying portfolio, we find that the fund's market-cap exposure is skewed:

Vanguard Growth Equity (VGEQX)
Market Capitalization % of Portfolio
Giant 34.81
Large 36.76
Medium 28.43
Small 0.00
Micro 0.00
Figure 2
Source: Morningstar

Let's look at Figure 3. Here we find that the value orientation of the fund is evident across a wide size spectrum, as follows:

Fidelity Value Fund (FDVLX)

Market Capitalization % of Portfolio
Giant 6.22
Large 31.86
Medium 44.92
Small 15.42
Micro 1.58
Fiugre 3
Source: Morningstar

Economic models suggest that your exposure to company size and choice of value vs. growth orientations are key factors in determining expected portfolio return. So, if you believe this theory to be true, you may want to take calculated positions in funds that give you precise size and style exposures. (To learn more, check out Build A Model Portfolio With Style Investing.)

The Role of the Mutual Fund Prospectus
Any time an investor purchases a mutual fund or exchange-traded fund (ETF), the fund company must legally provide you with a document called the prospectus. The prospectus is the fund's primary selling document and includes important information, including:

  • date of issue
  • the fund's investment objectives or goals
  • principal strategies for achieving those goals
  • management team
  • risks of investing in the fund
  • fees and expenses
  • past performance

The prospectus document can be daunting in terms of the amount of content it contains, but it should be part of your ongoing due diligence. (To find out how to dive into prospectus statements, check out Digging Deeper: The Mutual Fund Prospectus.)

Unfortunately, many investors often ignore the prospectus, skipping the process entirely and investing in the fund anyway. Many opt instead for reading the fund's one- or two-page fact sheet, which should not be confused with the prospectus. Fact sheets are usually updated monthly and serve merely as a guide or summary. They usually contain information about the fund's allocation and provide an abbreviated list of assets, recent performance and expenses. They are not intended to provide the scope nor the depth of a prospectus.

Direction of the Industry
A 2003 study found that mutual funds attracted investors in droves by adding trendy words to their title (e.g., "tech" and "internet growth" were often seen in the late 1990s). The study uncovered that funds that changed their names were found to attract 22% more new money than funds of similar size, investment style and other features that didn't undergo a name makeover, despite the fact the name change was purely cosmetic and no changes occurred in the way the fund invested. Mutual fund companies are well aware of the fact that a catchy mutual fund name can more easily attract investors into their funds, which is why each investor has a personal responsibility for conducting due diligence on their mutual fund investment choices. (To learn more, check out Due Diligence In 10 Easy Steps.)

The Bottom Line
Much like buying a car, investors should really consider "looking under the hood" before committing their cash to a specific mutual fund. A mutual fund's name does not always reflect a true picture of the investment.

Investors should consider screening the funds not by name, but by asset type and size classifications, and further evaluate how that fund might fit into their overall asset-allocation plan. Looking beyond fund names to examine actual portfolio holdings is much easier than you think, with the help of investment-tracking services available on the web. In short, before you buy, find out what you are actually getting.

To continue reading about this topic, check out Picking The Right Mutual Fund and Too Many Mutual Funds.

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: WisdomTree SmallCap Earnings

    Discover the WisdomTree Small Cap Earnings ETF, a fund with a special focus on small-cap and micro-cap stocks with positive earnings.
  2. Mutual Funds & ETFs

    ETF Analysis: iShares US Regional Banks

    Obtain information and analysis of the iShares US Regional Banks ETF for investors seeking particular exposure to regional bank stocks.
  3. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Low Volatility

    Find out about the PowerShares S&P 500 Low Volatility ETF, and learn detailed information about this fund that provides exposure to low-volatility stocks.
  4. Technical Indicators

    Key Financial Ratios to Analyze the Mining Industry

    Discover some the most important financial ratios used by investors and analysts to evaluate companies in the metals and mining industry.
  5. Technical Indicators

    Key Financial Ratios to Analyze Retail Banks

    Learn about key financial metrics that investors use to evaluate retail banks, and how the industry is fundamentally different from most other industries.
  6. Technical Indicators

    Key Financial Ratios to Analyze Airline Companies

    Examine some of the most important financial ratios and performance metrics investors use to evaluate companies in the airline industry.
  7. Stock Analysis

    The 5 Biggest Canadian Oil Companies

    Obtain information about some of the largest and most successful major integrated oil corporations that are headquartered in Canada.
  8. Technical Indicators

    Key Financial Ratios to Analyze Tech Companies

    Understand the technology industry and the companies that operate in it. Learn about the key financial ratios used to analyze tech companies.
  9. Stock Analysis

    3 Reasons to Continue to Own Monster Beverage

    Learn more about the Monster Beverage Corporation and some of the primary reasons why investors and market analysts like the stock.
  10. Markets

    The 5 Biggest Canadian Insurance Companies

    Learn more about the insurance industry as a whole, how it functions in Canada, and the five largest Canada-based insurance companies.
RELATED TERMS
  1. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  2. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  3. Series 6

    A securities license entitling the holder to register as a limited ...
  4. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  5. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  6. Net Present Value - NPV

    The difference between the present values of cash inflows and ...
RELATED FAQS
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  2. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  3. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>
  4. How can EV/EBITDA be used in conjunction with the P/E ratio?

    Because they provide different perspectives of analysis, the EV/EBITDA multiple and the P/E ratio can be used together to ... Read Full Answer >>
  5. How can a company reduce the unsystematic risk of its own security issues?

    Companies can reduce the unsystematic risk of their own security issues simply by doing the most effective job possible of ... Read Full Answer >>
  6. How can I find net margin by looking a company's financial statements?

    In finance and accounting, financial statements represent the fundamental means of analyzing a company's financial position, ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!