If we ignored the fact the fund is not diversified and looked only at performance, one could erroneously conclude that the fund is successful and falsely label this mid cap index fund as a “total market active winner.” In fact, any active fund that merely bought this mid cap index fund would receive the same grades.

Exhibit 1 - Comparison of IJH against a Total Market Domestic Equity Benchmark

	Portfolio Grades
		Overall	Diversification	Expense	Relative Risk	Return	Risk of Material Underperformance
IJH	Last 3 Years	C-	D+	A+	F	C+	C-
	Prior 3 Years	B-	D+	A+	C	B	C+
	Last 6 Years	C+	D+	A+	D+	B-	C

However, the diversification grade exposes the inaccuracy of the label “total market active winner.” Over all three time periods, the fund received a D+ for diversification, illustrating this is a poor benchmark for grading this fund. Of course, being a mid cap index fund, you would already know this, but what about the funds you might choose that are not so obviously misclassified?

Let’s contrast investing solely in this mid-cap fund to what, from a labeling perspective, would be an apparently more diversified portfolio of large-cap and small-cap funds, in order to achieve the desired allocation of the total domestic equity market. In Exhibit 2, we select four funds that Morningstar has rated “four stars.” Market cap is weighed at 70% large versus 30% small, so there is a slight bias toward small-cap (relative to a broad-market index), but not enough to materially alter results and styles are equally weighted eliminating any style bias.

Exhibit 2 - Portfolio weights for the “more diversified” portfolio of four star funds based on Morningstar’s asset class labels and the combined portfolio grades as weighted relative to the target allocation of Total Domestic Equities:

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