Analyzing an Equity Mutual Fund (Part 1)

I've been busy grading papers because it was the end of the quarter and then I took a much-needed break, but I'm back!

As promised, I will now analyze several equity mutual funds.  There are literally thousands of funds to choose. For my first fund, I opted to choose a fund that Morningstar.com decided to highlight today--the Wasatch Small Cap Growth fund, or WAAEX. The fund is highly rated by Morningstar. For my second fund I chose the Vanguard Total Stock Market Index Investor fund (VTSMX).

My goal for today's post isn't necessarily to state whether I think these funds are good or bad choices. My goal is to show you how to evaluate the fund in terms of diversification so that you will feel comfortable evaluating this aspect of mutual funds yourself. I'll also talk a bit about fees, to serve as a segue to a few posts about mutual fund fees.

All the information I will be using comes from Morningstar's free website. Morningstar does offer a premium service, but I will not be using it.

The Funds' Summaries

WAAEX

According to Yahoo's! Finance site, WAAEX's summary is:

The investment seeks long-term growth of capital; income is a secondary consideration. The fund invests primarily in small growth companies. It will invest at least 80% of the fund's net assets in the equity securities of small-capitalization companies. Equity securities include common stock, preferred stock and securities convertible into common stock, warrants and rights, and other securities with equity characteristics. The fund may invest up to 20% of its total assets at the time of purchase in securities issued by foreign companies in developed or emerging markets.

I bolded several important bits.  First, WAAEX has set a floor for the percentage of the assets that must be invested in small cap companies--no less than 80% of the firm's assets.  That means no more than 20% of the fund's money can be invested in non-small cap equities. Also, no more than 20% of the fund's assets can be invested in securities of foreign companies.  WAAEX is an actively-managed fund.  It is trying to find small cap growth stocks that it believes will generate high returns in the future.

VTSMX

According to Yahoo's! Finance site, VTSMX's summary is:

The investment seeks to track the performance of a benchmark index that measures the investment return of the overall stock market. The fund employs an indexing investment approach designed to track the performance of the CRSP U.S. Total Market Index, which represents approximately 100% of the investable U.S. stock market and includes large-, mid-, small-, and micro-cap stocks regularly traded on the New York Stock Exchange and Nasdaq. It invests by sampling the index, meaning that it holds a broadly diversified collection of securities that, in the aggregate, approximates the full index in terms of key characteristics.

Again, I have highlighted some important bits. First, VTSMX is a passively-managed fund--an index fund. Its goal is not to seek out equities that will outperform the market. Rather it attempts to emulate the market as measured by the CRSP U.S. Total Market Index (an index that contains nearly 4,000 companies). Secondly, VTSMX invests mainly in equities from U.S. based companies--we shouldn't expect it to contain many foreign stocks. Also, it invests across essentially all levels of market cap.  It does not focus on small cap companies like WAAEX does. The objective also states that VTSMX invests by sampling the index. This means that it may not hold every security contained in the CRSP U.S. Total Market Index. Even if it does hold all the securities, they may not be weighted exactly the same as the CRSP U.S. Total Market Index.

Obtaining Information for a Mutual Fund

To obtain information for a mutual fund from Morningstar, access the website and enter the name (or a portion of the name) or the mutual fund symbol into the quote search box as shown below.

WAAEX

Below is a screenshot of a portion of the landing page for the quote search. It shows the tabs of information available. Most of the data I'll discuss today will come from the PORTFOLIO tab. Premium features are denoted by the '+' symbol in the purple arrow.

The above screenshot tells us a few things about WAAEX. First, it currently costs about $52 (down $0.44 from yesterday, or a drop of 0.83%) to buy a single share of WAAEX. It is possible to purchase a fraction of a share of a mutual fund. Thus, if you already had an account with Wasatch and you already owned some shares of WAAEX, you could add $100 to that account and purchase nearly (but not quite) two additional shares of WAAEX.  WAAEX currently has about $2.4 billion under its management. It's considered a small cap growth fund (see my Stock Classification posts if you don't know what that means) according to the Investment Style matrix. WAAEX charges an annual expense ratio of 1.21% (more on that in a later post) and if you wish to purchase shares of WAAEX for the first time, you'll need at least $2,000 to make that initial purchase. Unfortunately, WAAEX has a "limited" status, which means that its shares are currently not available to new investors. If you are an existing investor (you already own shares of WAAEX) you can purchase more shares. Funds typically limit their availability if the assets under management have grown substantially and the manager(s) of the fund believe it may be difficult to continue to achieve the fund's objective if the fund grows much larger.

VTSMX

VTSMX costs about the same per share as WAAEX--$52. However, there are quite a few differences between the two mutual funds! First, VTSMX manages quite a bit more money than WAAEX--$404 billion vs $2.4 billion. Secondly, VTSMX has a much lower expense ratio of 0.17% compared to WAAEX's 1.21%. Remember that WAAEX is an actively-managed fund while VTSMX is a passively-managed fund. That's the main reason for the different expense ratios--more on that in a future post. 

VTSMX requires a minimum initial purchase of $3,000 compared to WAAEX's $2,000. However, while WAAEX had a limited status, VTSMX is OPEN. This means new investors are welcome to open an account and existing investors may invest more in the fund. Also, while WAAEX is has a Small Growth "Investment Style," VTSMX has a Large Blend style.

Broad Asset Allocation

WAAEX

WAAEX is an equity fund--about 95% of the fund's assets are invested in stocks. Most (73.79%) of the stocks are in U.S. based companies while the remainder (20.83%) are non-U.S.-based companies. Notice that the 20.83% is slightly above the 20% in foreign securities as mentioned in its objective at the top of this post.

From PORTFOLIO tab of Morningstar.com's WAAEX search results.

About 4% of the fund's $2.4 billion in assets is held in the form of cash. This isn't necessarily unusual. When a person wishes to sell shares of a mutual fund (called redeeming one's shares) the mutual fund must exchange the shares for cash. Thus, a mutual fund needs some cash on hand because basically every day it will be redeeming some investors' shares. Most mutual funds tend to keep their cash balance around 5%, so WAAEX is fairly normal.

VTSMX

VTSMX is also an equity mutual fund so we should expect nearly all of its assets to be invested in equities. Based on the screenshot below, we can see that this is true.

From PORTFOLIO tab of Morningstar.com's VTSMX search results.

However, since VTSMX is designed to emulate the CRSP U.S. Total Market Index we should not expect it to contain many non-U.S. stocks, and it doesn't. The bulk (98.16%) of VTSMX's investments are in U.S. stocks.

Holdings Style

WAAEX

According to its objective, WAAEX is a small cap growth fund. Let's evaluate WAAEX's Holdings Style to see if it really is a small cap growth fund.

The Holdings Style box contains the percentage of assets that are invested in each type of equity. Thus, WAAEX has 55% of its stocks invested in small growth stocks, 30% in mid cap growth stocks, 8% in large cap growth, 6% in small cap blend stocks and 1% in small cap value stocks. While WAAEX does not have ALL of its money invested in small cap growth stocks, it is fairly focused on that area. However, WAAEX's objective stated that the fund would invest at least 80% of its assets in small cap stocks. It is not meeting that objective. Indeed, 8% of the firm's assets are invested in large cap growth stocks. The dark blue dot in the Ownership Zone shows that most of its stocks are considered small cap, high growth stocks. The lighter blue circle around the dot shows the makeup of the bulk (75%) of the fund's equity investments. The light blue circle is fairly small. This is a stark contrast to VTSMX.

VTSMX  

As VTSMX is more broadly diversified across the market caps and WAAEX is focused on small cap growth stocks, their Holdings Style and Ownership Zone matrices are much different. Notice how large VTSAX's light blue circle is, and how the Holdings Style contains percentages in each cell of the matrix.

VTSMX's weighted holdings (the dark blue dot) fall under the category of large cap, core stocks, making it a Large Blend fund. However, it contains a broader mix of stocks than WAAEX. VTSMX contains stocks across all the market cap sizes and it also contains value stocks, growth stocks and blend stocks.

For the next post, I will continue comparing these two funds in terms of the make-up of their portfolios.