When It Comes to Investment Styles, It’s Time to Think Outside the Box

How a mutual fund grows your money--in other words, the types of stocks or bonds it invests in--should be just as important to you as how much it grows. That’s what the experts say.

While the point of investing is having more money later than you have now, focusing too much on returns--without paying attention to how those returns are achieved--can be ruinous.

For instance, if all you cared about was getting top dollar returns, you might have put all your money into emerging-market stock funds in 1993. Had you kept it there, chances are you would have lost money in virtually every year since.

Obviously, no one can predict with absolute certainty when some types of stocks will come into--and go out of--favor.


To avoid such a scenario, “modern portfolio theory” teaches us to diversify our holdings among different types of stock and bond funds at all times. And the modern mutual fund industry helps us get there.

But is it doing too good a job?

By now, many fund investors have heard of different investing “styles” (such as growth investing or value investing) and the “style boxes” that monitor them. Style boxes, popularized by fund tracker Morningstar Inc. and printed in many of its mutual fund reports, indicate the types of stocks a fund invests in.

For instance, the style box shown on the left side of the graphic accompanying this story indicates a fund that invests in large domestic growth stocks--that is, shares of U.S. companies whose earnings are rapidly expanding. The style box on the right is that of a small-cap value fund. Such a fund invests in small companies whose shares are considered undervalued relative to their earnings or tangible assets.


Style boxes (which are routinely updated) will let you know if your large-cap growth stock fund is sticking with large U.S. growth stocks. And if your small-cap value fund actually invests in small-cap value stocks. By and large, this is a good thing. After all, if your small-cap value fund begins investing in large-cap growth stocks, you could become overly dependent on one style of stock.

But ask yourself: Would you rather invest in a fund that sometimes strays from its style box but makes you money every year? Or would you prefer to keep your money in a fund that’s always true to its style but loses money on occasion.

The politically correct answer in this style-box-driven world is the latter, not the former.


Today, there are nine styles for domestic stock funds: large growth, large blend, large value, mid-cap growth, mid-cap blend, mid-cap value, small growth, small blend and small value. Not to mention all of the “specialty stock” and “hybrid” fund classifications that Morningstar pegs stock funds into.

And while Morningstar does not break out its foreign funds into nine style categories of their own, the company has indicated that it might do so in the future.

For instance, a number of fund companies, including AIM, MFS and Northstar, have recently launched style-specific international funds. And the list is growing. “Even funds that haven’t made that distinction are tending to be more growth-oriented or value-oriented by nature,” said Gregg Wolper, international stock fund editor for Morningstar Mutual Funds. So long-term, “we probably would be heading toward making those distinctions” among foreign funds, Wolper said.

If that’s the case, we could be looking at 18 different types of stock funds--once again, that’s not counting the specialty stock categories. Think about how absurd it would be--shopping around for the best Asian/Pacific ex Japan mid-cap blend fund.


Style has become such a prevalent issue in the industry that “we’ve got clients who want us to [seek acquisition candidates] that specifically fill a Morningstar box,” said John O’Shea, vice president for mergers and acquisitions at Investment Counseling Inc., a fund consulting firm based in West Conshohocken, Pa.

Not surprisingly, fund managers don’t particularly like this trend, which they blame on consultants.

“You may be squeezed into a style box that you don’t feel particularly comfortable in,” said Charlie Mayer, manager of the Invesco Industrial Income fund. “So what do you do? Do you constantly change your investment style to satisfy the box? I don’t think you should.”

But if you don’t, you could find it difficult attracting money. Tom Barry, chief investment officer for George D. Bjurman & Associates in Los Angeles, runs what he calls an “all-cap fund” for his private clients. He invests in whatever size stocks he feels represent the best buys at a given time.


The problem is, “the consultants who seem to dominate the large pension and profit-sharing market like to categorize managers into styles and market caps,” Barry said, making it difficult to compete for assets.

What’s more, failing to adhere to the disciplines of your box could mean your returns will under-perform your peers’ (at least the peers you’re grouped in with).

Until a year ago, Mayer’s fund, Industrial Income, was listed as a “domestic hybrid” fund, Morningstar’s term for so-called balanced funds (those that invest in both stocks and bonds).

But at the beginning of this year, when its stock allocation shot up to 70% of total assets, the fund was reclassified as a pure domestic stock fund--more specifically, as a large-cap blend fund.


“I went from being in the top quartile in every time period to under-performing,” Mayer said, noting that because his fund also holds bonds, it can’t really compete with pure stock funds.

Clearly, there’s a need to categorize funds. Styles and style boxes help us diversify our portfolios and compare our funds to others. But there’s got to be some room for flexibility. If not, we run the risk of style-boxing all of our managers to death.

We run the risk of forcing all managers to pick stocks because they fit a style, not because the manager believes they have the best long-term prospects for growth.

We run the risk of overlooking good but difficult-to-describe funds simply because they’re round funds in a square-pegged style box world.


Funds like Mayer’s portfolio, which has delivered annualized returns of 15% a year, on average, for the last 15 years. Or UAM FPA Crescent, Steve Romick’s promising domestic hybrid fund that Morningstar says adheres to a small-cap value style when it comes to equities.

Surely there’s got to be room in our portfolios for such funds--even if they occupy only 5% of our money. Right?

Notes Mayer: “Now, when people ask me what box to put my fund in, I tell them to just put it in the ‘in’ box.”

Times staff writer Paul J. Lim can be reached by e-mail at



Style Boxes

Fund tracker Morningstar Inc. has popularized the idea of categorizing mutual funds by one of nine “styles” to describe the predominant types of stocks owned by the fund. These styles are illustrated on box grids, such as the equity “style boxes” shown below. At left, a large-capitalization blend fund; at right, a small-cap value fund.

Source: Morningstar Inc.