Determining the Optimal Mutual Fund Style Classification Methodology

There are currently two primary methodologies used to classify the investment style of mutual funds: holdings-based style analysis (HBSA) and returns-based style analysis (RBSA). HBSA classifies any investment based on the underlying holdings in the portfolio (what it is), while RBSA classifies an investment bond upon its historical returns (what it did).  While there has been research noting the advantages and disadvantages of each strategy, little research has been conducted to determine which classification methodology results in a more consistent definition of mutual funds and which methodology best determines the likely future style of a mutual fund.  This paper will explore this topic in order to determine the ideal methodology for classifying mutual funds as well as provide a general discussion of HBSA and RBSA.