Finance, Forex and Investments

Why do some mutual funds have holdings in penny stocks and how do they do their research?

I own some mutual funds that have penny stocks now as part of their portfolio in their top 10 at least. How do they research them?

Public Comments

1. They research them the same way they research all their other holdings. They use ratios like price/earnings, debt/equity, also profit margin, growth, etc. Additionally, there is a more subjective part of what the fund manager believes to be a potential "break out." That is to say finding an undervalued stock that hasn't been recognized on a large scale by Wall Street or the general public so that it has an even greater potential of exponential rewards. I would keep my own portfolio balances if I were you and not overweight to heavily on these penny stocks that are more typically referred to as "growth stocks" but sometimes all it takes is one big hit to offset all your other losses. Be careful and good luck!
2. All public companies have to report their financials and current activities, so they mainly use that. It is illegal to have insider information and trade the stock of a public company, so they can't do much more than read what's been published. Most mutual funds select the market the company is in, as well as the size of the company first e.g. small cap biotech (which is hot right now). They then take all of the companies that fit this criteria and pick the one most poised to do well based on their reports.