he largest category is that of equity or stock funds. As the name implies, this sort of fund invests principally in stocks. Within this group is various sub-categories. Some equity funds are named for the size of the companies they invest in small-, mid- or large-cap. Others are named by their investment approach: aggressive growth, income-oriented, value, and others. Equity funds are also categorized by whether they invest in domestic (U.S.) stocks or foreign equities. There are so many different types of equity funds because there are many different types of equities. A great way to understand the universe of equity funds is to use a style box, an example of which is below.
The idea here is to classify funds based on both the size of the companies invested in (their market caps) and the growth prospects of the invested stocks. The term value fund refers to a style of investing that looks for high quality, low growth companies that are out of favor with the market. These companies are characterized by low price-to-earnings (P/E), low price-to-book (P/B) ratios, and high dividend yields. On the other side of the style, spectrum are growth funds, which look to companies that have had (and are expected to have) strong growth in earnings, sales, and cash flows. These companies typically have high P/E ratios and do not pay dividends. A compromise between strict value and growth investment is a “blend,” which simply refers to companies that are neither value nor growth stocks and are classified as being somewhere in the middle.
Learn how to use the Morningstar Style Box (TM). Morningstar The other dimension of the style box has to do with the size of the companies that a mutual fund invests in. Large-cap companies have high market capitalizations, with values over $5 billion. Market cap is derived by multiplying the share price by the number of shares outstanding. Large-cap stocks are typically blue chip firmsthat are often recognizable by name. Small-cap stocks refer to those stocks with a market cap ranging from $200 million to $2 billion. These smaller companies tend to be newer, riskier investments. Mid-cap stocks fill in the gap between small- and large-cap.
A mutual fund may blend its strategy between investment style and company size. For example, a large-cap value fund would look to large-cap companies that are in strong financial shape but have recently seen their share prices fall and would be placed in the upper left quadrant of the style box (large and value). The opposite of this would be a fund that invests in startup technology companies with excellent growth prospects: small-cap growth. Such a mutual fund would reside in the bottom right quadrant (small and growth).