Digging Deeper Into Mutual Fund Names

Most mutual fund names are simple and fairly easy to understand. For example, many investors recognize that most mutual funds with small-cap value in their title invest in smaller companies that fund managers believe to be inexpensive.

For the most part, the standard fund names that describe an investment style, like small-cap value and large-cap growth, accurately describe a fund’s investment strategy. It’s the more generic or vague names that can be much more confusing for the average investor. Read on to find out why.

Equity Income vs. Growth and Income

You may be wondering: What’s the difference between equity income or growth and income? Not much, at least when it comes to the implication of the fund name. Equity-income funds invest mainly (but not exclusively) in large-cap stocks that pay high dividends. This is often coupled with some sort of fixed-income asset exposure. These types of funds tend to be more value-oriented.

Growth and income funds are not far off. These types of funds also aim to provide both growth and income by investing in companies that are poised for earnings growth and also pay some dividends. Growth and income funds tend to be more of a blend and sometimes more geared toward growth as opposed to value.

A simple screen in the Morningstar database would serve as fair evidence. Using the Morningstar style box as a filter, Figure 1 shows how these funds are mapped out within the style box.

Investors who want both current income and moderate capital appreciation, such as retirees, would be well suited to owning either type of fund.

Source: Morningstar

Large-Cap vs. Small-Cap Investing

Some mutual fund names are not very detailed, so screening for funds based merely on their investing style does not always reveal the fund’s exposure to market capitalization. For example, growth funds or value funds can invest in large or small companies.

Let’s take a look at Figure 2 as a case study. By taking a deeper look at the fund’s underlying portfolio, we find that the fund’s market cap exposure is skewed.

American Funds Growth Fund of America (AGTHX)

Fidelity Value Fund (FDVLX)

If we look at the fund information for FDVL, we find that its value orientation is evident across a wide size spectrum, as follows:

Economic models suggest that your exposure to company size and choice of value versus growth orientations are key factors in determining expected portfolio return. So, if you believe this theory to be true, you may want to take calculated positions in funds that give you precise size and style exposures.

The Role of the Mutual Fund Prospectus

For all mutual funds or exchange-traded funds (ETFs), the sponsor or fund company must provide you with a document called the prospectus. The prospectus is the fund’s primary selling document and includes important information, including:

• Date of issue
• The fund’s investment objectives or goals
• Principal strategies for achieving those goals
• Management team
• Risks of investing in the fund
• Fees and expenses
• Past performance

The prospectus document can be daunting in terms of the amount of information it contains, but it should be part of your pre-purchase due diligence. Unfortunately, many investors often ignore the prospectus. They skip the process entirely and invest in the fund anyway.

Many opt instead for reading the fund’s one- or two-page fact sheet, which should not be confused with the prospectus. Fact sheets are usually updated monthly and serve merely as a guide or summary. They usually contain information about the fund’s allocation and provide an abbreviated list of assets, recent performance, and expenses. They are not intended to provide the scope nor the depth of a prospectus.

The Importance of Fund Names

The Securities and Exchange Commission (SEC) introduced Rule 35d-1 in 2001 to regulate the mutual fund industry’s use of fund names. The rule was adopted under the Investment Company Act of 1940 and requires companies to invest a minimum of 80% of their assets in the investment type suggested by their names. According to the rule, a fund that has the word energy in its name should invest at least 80% of its assets in energy-related investments.

But just how important are fund names? Experts suggest that mutual fund names often provide investors with a window into their investment strategies. A study published by European scholars in 2020 examined 2,152 equity funds in the United States between 2010 and 2018.

It found that about 33% of the funds analyzed had an inaccurate name at some point in their lifetime. These inaccuracies generally pertained to the fund size (small or large) and the fund’s investment strategy (growth and value)—the latter being the most prominent.

The scholars found that inaccurately named funds not only mislead investors but they found that these funds:

• Are older
• Come with higher expense ratios
• End up with lower fund inflows

The Bottom Line

Much like buying a car, investors should really consider looking under the hood before committing their cash to a specific mutual fund. A mutual fund’s name does not always reflect a true picture of the investment. Investors should consider screening the funds not by name, but by asset type and size classifications. They should also evaluate how that fund fits into their overall asset allocation plan. Looking beyond fund names to examine actual portfolio holdings is much easier than you think, with the help of investment-tracking services available on the web. In short, before you buy, find out what you are actually getting.