Digging Deeper Into Mutual Fund Names

by Cathy Pareto,CFP®, AIF® (Contact Author | Biography)

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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.

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 towards 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 should be read as 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.)

Conclusion
In closing, 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 what you are buying.

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, including Morningstar.com. 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.

by Cathy Pareto (Contact Author | Biography)

Cathy Pareto, MBA, CFP®, AIF®, is the founder and president of Cathy Pareto & Associates, Inc., Investment Management and Financial Planning. Cathy has more than 12 years of experience in the financial services industry. After a 10-year engagement as a senior financial advisor with a large investment management firm, Cathy decided to pursue her passion for helping individuals, families, small businesses, young executives, and other professionals that have substantial investable assets, but who fall below most large investment advisory firms' account minimum requirements.

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