Style Drifters

In the 1980s, Fidelity’s Magellan fund and its then-manager Peter Lynch were touted for outpacing the S&P 500 Index. However, Lynch had achieved his big returns by concentrating a large portion of the fund’s holdings in small cap stocks. In so doing, his investors were unwittingly exposed to a higher level of volatility that may not have been in line with their investment objectives. Magellan’s returns looked good when measured against the S&P 500 Index, an inappropriate benchmark that included no small cap stocks. The appropriate benchmark for Magellan would have been a blended index of both small cap and large cap equities.

Figure 6-4 illustrates the style drift of Fidelity’s Magellan fund from January 1, 1982 through December 31, 2017. The scale on the vertical axis represents the fund’s relative exposure to different styles, and the different colors represent different investing styles. In 1995, the fund looked like a large value fund (green), but between 2000 and 2009, it would have been seen as a large growth fund (blue). This ongoing shift causes the fund’s investors to unknowingly be allocated to risks different from what they thought.

In the mid-1990s, Jeffrey Vinik took over the fund’s helm. He made a famous market call in November 1995, bailing out of $10 billion worth of technology stocks. This is visible in Figure 6-4 by the disappearance of the blue section (Large Growth) in 1995. He put a lot of that money into cash and bonds. During the next six months, Magellan’s value barely moved, as the Large Growth index grew by 11.3%. As a result, investors suffered from lower returns and higher capital gains taxes.

Figure 6-4


To expand the analysis, let’s look at two additional mutual funds whose exposure to different styles drifted over time. Figure 6-5 displays the style drift of the actively managed Vanguard Explorer Fund, which is designated by Vanguard as a small growth fund. Note that the tan zone is a small growth index, and the brown is a small value index. The fund experienced a spike in exposure to small value in the early 1990’s, shifting it away from its original allocation and altering its risk exposure for its investors.

Figure 6-5


Similarly, Figure 6-6 illustrates the style drift of the Growth Fund of America, which is designated as a large growth fund. Note the lack of style consistency as the various indexes in the fund seem to move up and down like a roller coaster. Both of these funds did not stay true to their stated identity.

Figure 6-6

Step 6Peter LynchMagellan fundS&P 500Jeffrey VinikVanguard Explorer FundGrowth Fund of America