Diversifying is sometimes easier said than done

Staying Ahead

November 25, 1996|By JANE BRYANT QUINN

ALL SERIOUS investors know they ought to diversify their mutual-fund holdings. But what does diversification mean?

It doesn't mean owning four different growth funds, which is probably the average stock investor's most common failing. When growth-stock investing falls out of fashion, as it does occasionally, all those funds will stall together.

To be properly diversified, you need funds with different investment styles. That might mean one growth fund that buys big-company stocks, one that buys smaller companies, one value-stock fund and one fund with international holdings.

That way, you have something going in almost any market climate. When growth stocks lag, your value stocks should charge ahead.

But building a diversified portfolio is easier said than done. A fund's name may not reflect the types of stocks it contains. A manager may switch styles. The fund's objective, as stated in the prospectus, may be hopelessly vague.

For example, what, exactly, is a "capital appreciation" fund or a "growth and income" fund?

Very different types of funds may claim the same investment objective. We need better definitions, to help us tell one type of fund from another.

A new move by Morningstar, a mutual-fund research firm in Chicago, should advance this cause.

Morningstar tracks mutual-fund performance. It awards stars to the best performers in four large fund groups -- U.S. equity, international equity, taxable bond and municipal bond.

This month, Morningstar is unveiling a second rating system. Mutual funds are being grouped into 44 categories, according to their investment styles -- for example, big-company growth funds, small-company growth funds, utility funds, Europe funds, long-term municipal bond funds, intermediate-term taxable bonds and so on.

The best performers in each group are to be assigned "category ratings" based on the past three years of risk-adjusted data. The top 10 percent of the funds in each group will get a "category five" rating, second-tier funds get a "category four" and so on.

This supplements Morningstar's star-rating system, which will coexist with the new category ratings.

Morningstar decides for itself what category a fund belongs to, based on the investments it holds.

Benham Equity Growth Fund, for example, is classified as a JTC big-company value fund, not a growth fund, says Morningstar's Amy Arnott. Dean Witter American Value has a growth-fund investment style.

At first, investors will find these new categories only in Morningstar's own software and publications, such as its monthly mutual-fund newsletter Morningstar Investor ($79 a year; call 800-735-0700). Eventually, newspapers and online services that use Morningstar data may decide to publish the categories, too, Morningstar publisher John Reckenthaler told my associate, Kate O'Brien Ahlers.

You can also count on the funds with high ratings under the new category system to advertise that fact immediately. The ads should direct your attention to each mutual fund's style, rather than to woozy definitions like "aggressive growth."

One warning about Morningstar ratings, both the stars and the new category ratings: They reflect past performance only. You can't rely on them to predict the future. A three-star fund may be ready to rise while a five-star fund could be due for a pause.

The ratings, however, do steer you away from funds whose total returns have fallen well below average.

If you own several mutual funds, take a look at their investment style to see if you're diversified enough. You need small stocks and large stocks, value and growth investment styles, and some international holdings.

Pub Date: 11/25/96

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