FRC, a mutual fund research company in Boston, has issued a warning against a wrinkle in the new fund classification system which Lipper Inc. of Summit, N.J., is set to begin using next month.

Lipper's 14 new, narrow classifications for U.S. diversified equity funds - classifications based on market capitalization and investment style - could be undermined by four so-called "super-group" rankings that take only market capitalization into account, FRC said in a report issued in June. Mutual fund companies can choose to be ranked in either Lipper's 14 narrow classifications or the four super-groups - large-cap, multi-cap, mid-cap and small-cap - for their advertising and marketing materials.

Lipper designed its 14 new classifications for U.S. diversified equity funds last December to replace eight classifications in order to clarify groupings for investors and intermediaries, said Steven Lipper, marketing director for Lipper (MFMN, 6/14/99). An increasing variety of funds made it apparent to Lipper that additional categories were needed, he said.

Lipper said it also created the four alternative super-group categories to accommodate portfolio managers with wide investment mandates and who might drift between growth and value styles, for instance. Lipper was not available to comment on FRC's criticism.

But Christopher J. Brown, an analyst with FRC, said that grouping funds under market capitalization will allow funds with various styles - growth, value, core and blend - to be compared. He said this could tempt mutual fund companies to use these broader classifications in order to put their funds in the best light. For instance, comparing growth funds and value funds is particularly beneficial to growth funds, Brown said. He also estimated that there are only 100 U.S. domestic equity funds that shift investment styles and could justifiably fit the super-group ranking.

Brown suggested that Lipper came up with the super-group concept as a "panacea [for] firms unhappy with the new rankings."

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