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Mutual Funds

How Fund Raters Figure Styles

Morningstar and S&P take differing approaches to categorizing funds.

Morningstar begins its determination of a fund's style by categorizing the style of every stock in its universe, which includes about 99% of all U.S. stocks (Morningstar tracks foreign stocks separately but uses the same methods). Figuring a stock's size categorization is fairly straightforward. Those that make up the top 70% of total stock market capitalization are considered big, those in the next 20% are considered midsize, and all the rest, representing the overwhelming majority of stocks, are small-cap.

Determining where a stock falls on the growth-value spectrum is trickier. Morningstar looks at ten factors. Five represent value: price to book value, price to sales, price to cash flow, dividend yield, and price to projected earnings. Five measure growth factors: long-term expected earnings growth, and historic book-value growth, sales growth, cash-flow growth and earnings growth. Based on all of these factors, every stock is assigned a growth score and a value score. A stock with a low value score and a high growth score is considered a growth stock; one with a high value score and a low growth score is deemed a value stock. If neither growth nor value dominates, a security is considered a core stock.

Morningstar then applies these stock styles to an entire fund portfolio. For example, funds that tend to have mostly large-cap growth stocks will be labeled large-cap growth funds. Stocks representing big positions in a fund have more influence in the determination than stocks that represent smaller positions. Funds that own a mix of growth and value stocks fall into the blend category, and those that own companies of various sizes tend to fall into the midcap grouping.

Standard Poor's, which provides fund data for Kiplinger's, takes a different approach to categorization. It compares the performance of funds with the performance of its own stock indexes over the previous three years. The basic principle is that if a fund is tracking, say, the SP 600 value index, which measures small-cap value stocks, then it must be a small-cap value fund. And a fund that tracks the famous SP 500 index must be a large-cap blend fund. But SP also checks fund holdings periodically to make sure the index-comparison analysis isn't sending false signals, says analyst Srikant Dash. Unlike Morningstar, SP has "all-cap" categories for funds that invest in companies of all sizes.