Selecting a Suitable Large-Growth Fund

Josh Charlson, CFA: Growth stocks have been on an unbelievable run over the past decade, far outperforming value. Perhaps you're thinking of adding a large-growth fund to your portfolio or replacing one that has underperformed. It's not as simple as just picking a fund that has performed well recently, because there can be significant differences in how a large-growth fund executes its strategy. I'm going to discuss some of the considerations you should take into account when selecting a large-growth fund.

First, what is the growth style of the fund manager? Some managers focus on rapidly accelerating firms, others on more-durable growers, while still others incorporate cyclical-growth firms like industrials. How the manager defines his or her focus can have significant effects on the risk and performance patterns of a fund.

A second consideration is concentration level. Some managers may choose to focus on anywhere from 25 to 70 of their best ideas, which may increase return potential but also boosts the possibility of a single-stock blowup hurting the whole portfolio. Other managers may choose to diversify across hundreds of holdings. You can look at a fund’s percentage of holdings in the top 10 or the total number of holdings to discern its level of concentration.

Something of a companion to concentration risk is sector allocation. Large-growth managers tend to invest more heavily in certain sectors, such as technology, healthcare, and consumer cyclicals. But some managers choose to up the ante by significantly overweighing or underweighting a given sector. You should examine those weightings relative to the fund’s benchmark and peers so that you know where those biases lie and decide whether you’re comfortable with them.

A further nuance to consider is the fund’s positioning in the Morningstar Style Box. Not only can the style box clue you in to whether the fund leans more heavily toward growth or tends to sprinkle in more core-type holdings, it can also inform you whether the fund manager has boosted returns from a generous sampling of smaller-cap firms.

Finally, you can look to various risk metrics for a fund to see how all of these individual aspects of the strategy add up. Standard deviation, a measure of volatility, is useful, but keep in mind that growth funds in general are more volatile than other fund types, so be sure to compare it to a relative benchmark or peer group. Risk-adjusted measures like Morningstar Risk and Sharpe ratio are more inclusive, while downside and upside capture ratios can convey the magnitude of potential gains and losses. Ultimately, you'll need to match up these various considerations to your own preferences and goals.