by Martin Chapman

Created on: March 21, 2009   Last Updated: October 31, 2010

A Mutual Fund's style should inform the retail investors about what type of mutual fund product they have bought. This is also useful for the portfolio managers, as they can choose  to specialize in particulars segment of the stock market, so that the manager becomes an expert in that niche area. Furthermore, if funds are categorized with style labels, then it is possible for the funds to be ranked against other funds with similar styles. This is useful for individual investors and for fund-of-fund managers, who can select the best performing funds based on the peer group rankings produced by agencies like Morning Star and Fitch.

There are many styles which can be used to classify and select portfolios. This article concentrates on the three styles which are used in building Global and European mutual funds, namely: Value; Growth; and Momentum.

THE VALUE STYLE

In choosing the value factors to use in ranking the stocks in the investment universe, a three-legged-stool approach was adopted. Each factor used in the selection process had to be either: a) proven by academic literature to have delivered outperformance historically (meaning no back-test was necessary); b) commonly used as a selection factor in the financial industry; or c) logical or economic sensible. If the factor satisfied all three criteria, then this was even better.

a) Ranking of PEG Ratios (Price Ratio relative to growth)

The PEG ratio is a simple tool which is well explained in Jim Slater's Book "The Zulu Principle". Essentially it is a tool to insure that a reasonable price is paid for a growth stock. Academic studies show however that, although the PEG can perform well over certain periods of time, it is not a consistent long term outperformer.

b) Ranking of the Dividend Yield (D/P)

The dividend yield is one of the most commonly used investment selection criteria. It is not a consistent outperformer over the long-term, but it does very well in Bear Market phases and is often more stable than the PE as earnings can fall or disappear for cyclical stocks during a recession.

c) Ranking of Dividend Cover

The dividend cover is defined as the earning divided by the dividend. It is included in the screening process to act as a control on the dividend yield. If a stock has a high dividend yield, due to a low price, but the dividend cover is high then the chances are better that the dividend will be maintained. If however the dividend cover is low then a cut

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