FA Magazine March 2025 | Page 42

uters — are also well-known , but more so to institutional investors .

Morningstar ’ s methodology identifies large capitalization companies as those making up the top 70 % of U . S . market capitalization . The next 20 % are mid-cap , and the remaining 10 % are small cap .

The numbers and sizes of the companies in these categories have been changing dramatically with the rapid appreciation of the largest companies . As recently as 2010 , almost all of the S & P 500 companies may have been characterized as large cap ( according to Siblis Research ). Fidelity still has an article from Bankrate on its website describing largecap firms as those with a market capitalization greater than $ 10 billion .

Right now , however , per Morningstar , the cutoff is actually more like $ 70 billion , and only about 150 firms meet this definition . The breakpoint among Russell 3000 firms as of February 2025 is currently between CVS ( ranked No . 149 as the smallest large-cap company with a $ 70 billion market capitalization ) and Williams Companies ( ranked No . 150 at $ 69 billion ) as the largest mid-cap .

Style Boxes Vs . Fund Categorization

The fund categorization labels used by Morningstar have not caught up with these changes .

In the U . S . equity markets , it is common to distinguish among large , midsize and small-cap stocks , and often further distinguish between growth and value styles of investing or a blend of the two . These equity subcategories are used by Morningstar in their equity style boxes — the familiar 3x3 grid with the columns representing investment style and the rows depicting company size . The darker the shading of a box , the heavier the weighting .

Mutual funds are categorized by Morningstar as though they fit into one of these nine boxes ( such as large blend ). At one time that may have been relatively true . However , the reality today is that these fund category descriptions can be very misleading . The capitalization-weighted S & P 500 index ( represented by the SPDR S & P 500 ETF Trust ) is well described by its categorization as “ large blend .”

But this doesn ’ t tell the whole story . This fund is 82 % in large-cap stocks and 18 % in mid-caps , according to Morningstar ’ s current definitions . And while it would be natural to assume this index leans toward growth stocks ( after the remarkable appreciation of the Magnificent Seven tech stocks ), it actually has 8 % more of its portfolio allocated to value .

A much more problematic example is the categorization of the equal-weighted version of the S & P 500 ( best represented by the Invesco S & P 500 Equal Weight ETF ). This is also labeled by Morningstar as a large-blend fund , even though it has less than a third of its holdings in largecap stocks and almost three times as much value as growth exposure ( making it look much more like a mid-cap value fund ).

Perhaps even more surprising is that popular mid-cap stock indices , captured by exchange-traded funds like the SPDR S & P MidCap 400 ETF or the iShares Core S & P Mid-Cap ETF , are only currently 30 % to 35 % allocated to mid-caps , with the large majority of their holdings in small companies .

If Morningstar ’ s description of these funds as mid-cap funds was shared with the participants of a 401 ( k ) plan , or the participants simply relied on the “ midcap ” name in these funds , they might rightfully object to being misled by the mutual fund , Morningstar , and / or the sponsor of the plan .

Ignorance Is Not Bliss

Investors who blithely assume that the SPDR S & P 500 ETF Trust is 100 % largecap , or that the S & P 400 mid-cap index is 100 % mid-cap , are badly mistaken . Advisors are effectively making the same mistake when they use portfolio management and reporting software that classifies fund holdings into a single asset class . Thus , they may be grossly overstating their client ’ s true allocation to large-cap stocks and widely understating their exposure to smaller companies .

This mistake could have been quite costly to returns during years like 2023 and 2024 , when there was a wide disparity in the performance of large and small capitalization stocks . During that period , the large company stocks of the S & P 500 earned close to double the return of the 2000 smaller companies in the Russell 2000 Index .

Morningstar ’ s Style Boxes

Percentages as of January 30 , 2025 .

Source : Morningstar .

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