Professional Documents
Culture Documents
b- Growth Funds
There are three main mutual funds types investors can choose from: growth, value and blend
funds.
As their names suggest, growth funds invest in stocks of companies that have the greatest
potential for long-term growth. While growth funds are generally volatile and are subject to the
fluctuation of the stock market, their long term potential is considerable. Indeed, there is no “free
lunch”. Within growth funds, three subcategories need to be distinguished: earnings-driven
funds, revenue-driven funds and blue-chip growth funds.
- Earnings-Driven Funds:
The majority of growth managers use earnings-driven strategies, which means they use a
company’s earnings growth as their gauge for determining how quickly the company is growing.
They want a company whose earnings are growing significantly faster than those of the average
company in its sector or the market as a whole.
- Revenue-Driven Funds:
Not all growth stocks have earnings. Some stocks may not produce earnings for years because
they have more spending than earnings. Young companies in the technology and biotechnology
industries are the perfect example. Some growth managers will buy such companies if they’re
generating strong revenues. However, since there is no guarantee when firms without earnings
will turn a profit or if they never will, this approach can be risky.
c- Value Funds
As opposed to growth funds, value ones focus on companies that are considered to be
undervalued in price and that are likely to pay dividends. The risk involved with this type is that
the market may not recognize that securities are undervalued and may not appreciate as
anticipated.
Although value investing makes a lot of intuitive sense (in fact, most same people would agree
that it’s better to buy a cheap stock than a pricey one), it does not pay off all the time. Both value
and growth stocks can be subject to major performance swings.
Although value funds generally show less volatility than growth funds, that doesn’t guarantee
safety. For instance, in many previous market downturns, such as the financial decline of 1990,
the utilities debacle of 1994, and the Asian crisis of summer 1998, value funds lost as much or
more money than growth funds.
d- Blend Funds
Although some of the best-known mutual fund managers use either growth or value approaches,
a giant group of fund managers splits the difference between these two investment strategies.
Within the blend category, the most common management style is the so-called growth at a
reasonable price approach (GARP). Managers who seek growth at a reasonable price try to find a
balance between strong earnings and good value. Although similar to the blue-chip growth style
we discussed earlier, blend funds differ in subtle ways. Some managers in this group find
moderately priced growth stocks by buying stocks investors have rejected; often, these
companies have reported disappointing earnings or other bad news and their stock prices may
have dropped excessively as investors overreacted by dumping shares. GARP managers also
look for companies that analysts and other investors have ignored or overlooked and that are
therefore still selling cheaply.
a- Foreign Funds
Foreign-stock funds’ returns can be appealing. In the past years, the typical foreign-stock fund
gained more than 20%, while S&P 500 index rose only about half as much. Foreign investing
can offer diversification. Foreign markets are often influenced by different factors than the U.S.
market, so adding foreign funds to your investment mix gives you a better chance of always
owning something that’s performing well. The addition of foreign stocks can actually reduce
your portfolio’s overall volatility level.
Moreover, the investment style you choose should depend on how much risk you can handle and
the other funds in your portfolio. If your U.S. stock funds lean toward growth stocks, consider a
foreign fund that’s more inclined toward value. If you think you might sell if a fund endures a
substantial drop, steer clear of foreign funds that emphasize small companies; they tend to be
more volatile than funds that focus on large firms. Remember, however, that small-cap stocks are
generally better diversifiers than foreign large-cap stocks, because large-cap stocks tend to be big
multinationals and often perform much like U.S.-based multinationals.
b- Small-Cap Funds
In recent years, small-cap funds did better than large-company rivals. This illustrates the benefits
of diversification. However, one should be prudent with small stocks, because they can be a lot
more volatile than large caps with the same investment style.
Small-value funds tend to have more dramatic ups and downs than their large-cap counterparts;
small blend is more volatile than large blend, and so on. Indeed, the best thing to do is to own a
mix of large and small stocks. You will benefit when the market favors one type of stock without
missing out completely when investors turn to the other. For most investors, smaller stocks
should represent between 10% and 20% of the stock portion of their portfolios.
c- Real-Estate Funds
Real-estate funds can add a lot of variety to a portfolio. They’re technically sector funds (see
definition), but they play such a distinct role in a role in a portfolio that they deserve to be treated
separately.
In fact, the average real-estate fund has remarkably low correlation with the S&P 500 index.
That means that when the S&P 500 goes up or down, real-estate funds probably won’t move in
sync with the index. That makes real-estate funds appealing when large-cap stocks are down. In
other words, real-estate funds do not behave much like large-cap U.S. stocks, which is what most
long-term investors have as the core of their portfolios. Nor do the funds behave like bonds,
which are the common choice to stabilize a stock portfolio. Adding real-estate fund to a portfolio
of stock and bond funds could add greater variety, resulting in a steadier performance. This
competitive advantage is partly attributable t the high dividend yields of many real-estate
securities. Most funds in the category invest predominantly in real estate investment trusts
(REITs), which pool together investors’ money and invest in income-producing property or
mortgage loans. REITs bring in a lot of income, but they’re required by law to pay out most of
that income as dividends to shareholders. That consistent yield can boost returns during good
times and offset losses in down years. Moreover, real-estate funds are more tax-efficient than
other income offerings such as bond funds because, for accounting reasons, part of their dividend
is considered a return of capital. That means not all of the yield paid by a real-estate fund will be
treated as income and taxed at that higher rate, whereas the entire yield from a bond fund is
likely to be taxed as income. (No need to mention, however, that it is not the right time to invest
in them).
d- Commodity Funds
Finally, another category of funds has been doing well over the past few years; commodity
funds. These funds don’t generally buy commodities directly, but rather buy derivatives that give
their portfolios exposure to fluctuations in the price of commodities such as oil, wheat, metals,
and hogs. Like real-estate funds, they exhibit a very low correlation with the U.S. stock market.
As stand alone investments, commodities funds are extremely volatile. But when used as a very
small piece in a broader portfolio, these funds’ limited correlation with the stock market means
they can actually reduce that portfolio’s overall volatility level and potentially improve its return
potential. Commodities funds also have the potential to help save off the ravaging effects that
inflation can have on your stock and bond holdings. In fact, commodities invariably gain in value
when inflation is rising.
****
Definition
Morningstar Inc:
A Chicago-based investment research firm that compiles and analyzes fund, stock and general
market data. Morningstar also provides an extensive line of internet, software and print-based
products for individual investors, financial advisors and institutional clients.
For example, if a company is currently trading at $43 a share and earnings over the last 12
months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/$1.95).
EPS is usually from the last four quarters (trailing P/E), but sometimes it can be taken from the
estimates of earnings expected in the next four quarters (projected or forward P/E). A third
variation uses the sum of the last two actual quarters and the estimates of the next two quarters.
Benchmark:
A standard against which the performance of a security, mutual fund or investment manager can
be measured. Generally, broad market and market-segment stock and bond indexes are used for
this purpose.
Investment style:
The overarching strategy or theory used by either a retail investor or an institutional money
manager to set asset allocation and choose individual securities for investment. The investment
style of a fund helps set expectations for long-term performance potential and aids in advertising
the fund to investors looking for a specific type of market exposure.
Small Cap: Refers to stocks with a relatively small market capitalization. The definition of small
cap can vary among brokerages, but generally it is a company with a market capitalization of
between $300 million and $2 billion.
Sector Funds:
A stock mutual, exchange-traded or closed-end fund that invests solely in businesses that
operate in a particular industry or sector of the economy. Because the holdings of this type of
fund are in the same industry, there is an inherent lack of diversification associated with these
funds.
Source: Investopedia
http://www.investopedia.com
Exhibit
Source: Quick Guide to Morningstar Style Box
http://mutualfunds.about.com/od/mutualfunds101/fr/stylebox.htm
Resources
Putnam Investments’ Family of Mutual Funds
https://www.putnam.com/individual/