Style drift happens
when an active manager drifts from a specific style, asset class, or index
that is described as the investment purpose of a portfolio or mutual fund. For
example, a manager may drift from small cap value to small cap growth.
This is a substantial problem if you have carefully determined your Risk
Capacity™ and matched it to a Risk Exposure.
Hypothetically, you may be intentionally invested in a growth fund. Then unbeknownst
to you, your active manager takes 30% of your Large Cap Stock fund and
puts it in cash and bonds. This changes your growth fund to a balanced
fund, changing the risk exposure, return, and time horizon of your investment.
To avoid style drift,
it is best to implement your asset allocation with "pure style"
index funds. Index funds are invested using clearly defined
rules of ownership. Forty percent of the time, actively managed
funds follow a manager's drift to a market that the manager
thinks will keep his shareholders happy and save his own hide. Unfortunately,
the shareholders suffer in the long run. As we have seen in previous
steps, this predicting or chasing of returns has resulted in "below
"Style drift is a serious problem for [investors] because it
distorts asset allocation and undermines performance when styles
rotate. Value managers who have drifted over the past three
years [1998-2000] toward more favored growth stocks are regretting
those moves, but not as much as their [investors]."
Surz, President, PPCA Inc., Get the Drift, 2001
''If a fund is drifting to a style that is dramatically different,
your potential returns, volatility, and risk are going to change.''
Pane, Director, S&P Fund Services Group, Spotting 'Style
Creep', When a fund starts to wander, returns
can suffer, BusinessWeek Online
"One thing is clear: Style drift happens to a sizable percentage
of mutual funds...For [investors or] planners seeking to create
portfolios tapping into consistently different equity styles,
style drift presents a significant concern."
"The SEC deems it a fraud if performance results are compared
to an inappropriate index, without disclosing the material differences
between the index and the accounts under management."
J. Zutz, "Compliance Review", Schwab Institutional,
Vol 10, Issue 8, Aug., 2001 [IFA comment: Any investment different
from the appropriate index will get different returns. Technically
speaking, the comparison of any active manager to any index
is inappropriate, due to style drift]
"How do you beat the S&P 500? You beat it by overweighting
some groups, underweighting others, and by owning stocks that
aren't in the S&P. [i.e. style drift]... Sometimes I think
if people knew how risky I was acting in the portfolio [Fidelity
Magellan] they'd really be surprised. Just go back a bit --
I made AOL very big; I made Yahoo very big. I'm not afraid to
make any bet."
Stansky, Manager Fidelity Magellan Fund, Inside the world's
largest fund, by Jason Zweig, CNN/Money, 4/15/2002
"To better communicate the sources of risk associated with mutual
fund investments, fund managers should provide estimates of
the principal risk factors that are likely to influence fund
returns in the future. Specifically, fund managers should describe
and quantify the expected relationship between their fund's
future returns and relevant security market indexes as well
as the likely extent of divergence [style drift] of their returns
from such indexes and the probable sources of such divergence.
In subsequent periods, actual fund returns should be compared
with the portfolio of market indexes previously selected by
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