What it means
The grid was popularised by the fund research firm Morningstar. One axis shows the size of the companies, measured by market capitalisation (share price multiplied by the number of shares).
The other axis shows style, which describes whether the shares look cheap relative to their fundamentals or are expected to grow quickly. Value shares tend to have low prices relative to earnings or assets, and often pay dividends.
Growth shares typically have higher prices relative to earnings because investors expect rapid expansion. Blend sits between the two, with features of both.
For investors, the box is a shortcut for checking diversification. A portfolio made up of several funds that all sit in the large-growth square is less diversified than it looks, because those funds will often rise and fall together.
A spread across different squares usually reduces dependence on a single type of share. The box is also used to check whether a fund is behaving as advertised.
If a fund describes itself as small-cap value yet shows up in the large-growth square, the manager may have drifted from the stated strategy. This is known as style drift, and it is worth asking about.
There are limits. The boundaries between squares are set by the classification provider and may be defined differently by others.
A fund may also hold shares across several squares, so the box is a summary, not a complete description. Different investors use the box in different ways.
Cautious investors may lean towards large-cap blend and value squares, while those seeking higher potential returns, and more risk, may favour growth and small-company squares. Neither approach is right for everybody, and the choice should reflect goals and time horizon.
In practice
Real-world examples.
Example
A financial planner reviews a client's retirement account and finds three funds all in the large-growth square. She suggests adding a mid-sized value fund. The change is intended to spread risk across different types of shares, so that one weak sector does not dominate.
Example
A pension trustee reads that a small-cap value fund now sits in the mid-cap blend square. The trustee asks the manager to explain. The manager says that some holdings have grown in size and that they plan to sell the largest. The trustee notes the explanation in the file and asks for a follow-up in six months.
Example
A graduate investing for the first time uses the box to compare two index funds, which look similar on the fund provider's website. One is large blend and the other is small growth. She chooses the large blend fund because she wants lower volatility. She plans to add a small-company fund later as her savings grow.
Case study
Seen in the real world.
Pinecrest Advisory is an illustrative, fictional firm that reviewed a client portfolio of five funds worth $500,000 in total. Each fund had a different name, so the client believed the portfolio was well spread.
Plotting the funds on the style box showed that four of the five sat in the large-growth square, and together they made up $420,000 of the portfolio. When technology shares fell sharply, the portfolio dropped by more than the client had expected.
In this illustrative story, the adviser moved $150,000 into mid-cap value and small-cap blend funds, selling part of the large-growth holdings to pay for it. The client was told that the new mix would sometimes lag in strong technology years, and she accepted that as the cost of steadier results. The new mix did not remove risk, but it meant that no single type of share dominated the results.
Watch out
Common mistakes.
- Assuming different fund names mean different holdings, when several funds may share the same style box square and hold many of the same companies.
- Treating the box as a prediction of returns, when it only describes a fund's current holdings and style and says nothing about how they will perform next year.
- Believing a fund stays in its square permanently, when changes in prices and manager decisions can move it over time, so the placement should be checked at least once a year.
Questions
People also ask.
What do the three style columns mean?
Value covers shares that look cheap, growth covers shares expected to expand quickly, and blend covers those with a mix of features.
How is company size decided?
It is based on market capitalisation, with provider-specific cut-offs for large, medium and small. Those cut-offs are reviewed from time to time, so a company can move between sizes without changing its business.
Does a bond fund have a style box?
Bond funds use a different grid, usually based on credit quality and interest rate sensitivity. The idea is the same: a quick picture of what kind of risk the fund carries.
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