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By Richard Loth (Contact | Biography)

An accurate determination of a mutual fund's investment objective is important for several reasons:

  • When building an investment portfolio, it helps to diversify the risk and return profile of your asset allocation.
  • It helps to avoid duplication in investment categories.
  • It allows the investor to monitor the manager's strategy performance over extended periods of time.
Fund Investment-Quality No.1 relates to the fund manager's ability and commitment to managing a mutual fund's assets according to the fund's stated investment objective over the course of several years.

For obvious reasons, consistency in this particular area is a very positive investment quality. Changes in fund management can trigger a change in investing style and should be closely monitored. Managers chasing performance have been known to resort to using different investing strategies, which often are counterproductive and change the risk profile of the fund. (For more insight, read Focus Pocus May Not Lead To Magical Returns.)

Nevertheless, fund investors need to exercise some flexibility when making judgments of a mutual fund's investment objective stability. According to an a June 2006 article by Chuck Jaffe, Don Phillips, Morningstar's managing director, was quoted as saying:

"You need to know where the funds are deployed, but it doesn't make sense to fire a great manager - or to ignore one - for using their discipline to make money. The key is knowing what a manager does and asking questions if you see a radical and unexpected change. But if you are paying for active management, let it happen, and don't worry so much that your large-cap value fund let some winners run and is now more of a large-cap blend fund. You're paying the manager to make those decisions."

The lesson to be learned from Phillips's remarks is that while the consistency of a mutual fund investment objective is undeniably an important investment quality, circumstances can justify giving the fund manager some leeway. Certainly, a history of consistent, above-average total returns would override any questions about style drift.

Using Morningstar's style boxes, here are some examples of investment style consistency, or lack thereof, over the 2001 - 2005 period, from a selection of mid cap blend mutual funds.

TCW Galileo Value Opportunities Fund (TGVOX)



Absolute perfection. Five-year annualized total return: 10.81%.

FPA Paramount Fund (FPRAX)



Nice consistency over the past four years, but it's falling into the mid cap growth style category as opposed to the fund's stated objective as mid cap blend. That said, it's hard to argue with the fund's five-year annualized total return of 14.9%.




Selected Special Shares Fund (SLSSX)



Better late than never! It took five years to make it to Selected Special's stated investment style category. The Fund's 2005 total return was 12.7% compared to the inconsistent five-year annualized total return of its style drift years of 1.3%.

Fairholme Fund (FAIRX)



This is a good example of a fund, which, at first glance, looks like the manager is all over the board when it comes to investment style. However, because the portfolio turnover rate is in the low 20s, this doesn't look like a conventional case of style inconsistency. The style drift is undoubtedly due to the fund's typical low holding of 15 to 25 stocks. With this level of portfolio concentration, just one significant transaction could easily change its style category. The fund's five-year annualized total return is 14.8%. This shows that there can be exceptions to the rule that requires style consistency to produce top-rated performance. (For related reading on this topic, see Understanding The Style Box.)

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Scoring Investment Style Data

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