Allan Roth: The Refresh of Morningstar’s Style Box
We look again at Morningstar's iconic style box, which the investment research firm has updated.
Last May, in I wrote that Morningstar’s style box was adrift and that the Vanguard Total Stock Market Index (VTI) was now considered a large-cap growth fund.
Morningstar had been working on a fix and announced a timeline for a style box refresh beginning with August data. In fact, the fund was given a below average Fi360 Fiduciary score due to its style drift and underperformance compared with other large cap core funds to which Morningstar still benchmarked it. According to the Fi360 rating:
The investment has considerable shortfalls. It may not be an appropriate choice if being considered in a search. However, if already in use, the investment may not need to be replaced pending further investigation or if the score improves in subsequent time periods.
Recently, Daniel Farkas, Morningstar’s Director of Portfolio Methodologies, confirmed that the implementation of new methodology had begun. Funds that have submitted their Aug. 31 holdings would be evaluated using the new methodology.
Indeed, the Vanguard Total Stock ETF made the following shift between July and August as can be seen by the percentage of holdings in each of the nine style boxes.

The first thing that jumped out was that large cap growth declined from 35% to only 16%. In the old methodology, large cap growth was nearly three times that of large cap value but in the new methodology, it’s a bit less than large cap value. In fact, value now accounts for 29% of the market and growth only 23% with the bulk in blend.
Does this mean the stock market is now value tilted? Farkas explained to me that this was not the case. One stock might just barely meet the criterion for value while another could be extreme in the growth category. The analogy is why the median can be so different than the mean.
An example would be the billionaires drive up the mean average net worth of Americans but have no impact on the median. Farkas proved his point with the following chart. The fund now has no value or growth tilt and is solidly in the center of blend. Note, however, that the average large blend fund (in yellow below) is even larger than VTI in market capitalization with a slight growth tilt.
Growth Tilt; Old Methodology
Farkas told me that slight growth tilt could change once all of the funds have submitted their end of August data since those that had not yet submitted this data are still evaluated with the old methodology.
I was a bit surprised that small cap only weighted 8% of the market since Morningstar targets weightings to be 70% large, 20% mid, and 10% small cap. Part was due to rounding as small cap totaled 8.44% but that’s still significantly less than 10%. Farkas schooled me again and noted that the Vanguard fund, using the CRSP US Total Market Index, omits certain micro-cap stocks due to liquidity constraints.
VTI has 3,653 holdings while Morningstar uses every listed stock in the U.S. which is currently about 4,700 holdings. In addition, the Vanguard fund uses free-float capitalization (not full market capitalization) to populate and weight the index while Morningstar uses full capitalization. As an example, like the vast majority of index funds, Vanguard excludes the Meta shares owned by its founder, Mark Zuckerberg.
Should an index fund use full capitalization? To see why they can’t, let’s look at an extreme example in an international stock index. Saudi Aramco is the most valuable international stock and sixth most valuable stock in the world with nearly a $1.8 trillion market capitalization. Yet less than 2% of the shares are free floated as the vast majority is owned by Saudi government.
If international stock index funds weighted to the full capitalization, there likely wouldn’t be enough shares available to buy. I think this makes a case for Morningstar to also benchmark to free float capitalization.
My Take
Earlier this year, I pointed out a problem with Morningstar’s style box that they were already aware of. That was easy; fixing it wasn’t. I applaud Morningstar and recognize the extreme complexities in benchmarking funds and the calculations in each style box.
Sometimes when I write about a problem with a financial firm, I get nasty emails or calls or even legal threats. I’m not in the least bit surprised that Morningstar took the opposite approach and reached out to me as they refreshed their ground breaking and immensely valuable iconic style box. Over multiple emails and calls, Farkas took a lot of time to explain the many issues involved.
I like the idea of Fi360s purely quantitative ratings but common sense must be applied. The market is the market and did not shift style boxes. It is neither tilted toward value or growth. And the reason for VTI’s underperformance vs. peers is because VTI owns a significant amount of mid and small cap stocks. It owns a smaller percentage of large-cap than its peers as seen in the previous image. Market performance has been driven by mega-caps over the past few years but that won’t always be the case.
Indeed, John Faustino, head of Fi360 wrote me that the Fi360 fiduciary tool “does not stand on its own as an investment decision-making tool” and that the fund is worthy of inclusion in fiduciary portfolios. He also stated that longer term average scores for the fund were very good.
Benchmarking fund performance is not an easy task. Choosing which funds are likely to outperform peer groups is even harder. Morningstar’s forward-looking methodology is part quantitative and part qualitative and gives VTI its highest gold rating. And Morningstar will soon be refreshing its forward-looking rating methodology as well.