Gallery:Step 6|Step 6: Style Drifters

Will "Go-Anywhere Funds" Get You to Your Destination?

Gallery:Step 6|Step 6: Style Drifters

When discussing the issue of style drift with prospective clients, we commonly hear an objection that goes something like, “Why should I care where my fund manager chooses to invest, as long as he is picking the asset class and securities with the highest returns?” Of course, the fallacy in this question lies in the premise that an active manager has the ability to divine which style, sector, or country will have the highest returns. As hard as we look for a predictable pattern, we just can’t see it—can you?

 

 

For those investors who believe that they can find a manager who has this ability, there is a Morningstar fund category to accommodate them, “flexible asset allocation”, which had 110 members as of June 30, 2013 and $365 billion of assets, representing a six-fold increase over the prior 15 years. Other names for this category include “unconstrained,” “absolute-return,” or most famously, “go-anywhere funds”. These are not quite the same as tactical allocation funds which have general guidelines such as 40-70% stocks but are allowed to drift within those guidelines based on market conditions. We previously addressed tactical allocation funds in this article.

Vanguard Research recently completed a study1 of these go-anywhere funds. As they noted, one of the challenges is choosing an appropriate benchmark since by definition, there isn’t one. Nevertheless, the funds are required to give a benchmark in their prospectus, so the authors compared them to that benchmark as well as a passive 60% equity/40% bond benchmark. They also tested for alpha using two other methods (style analysis and risk-factor analysis) that involved a regression analysis of historical returns. Lastly, they compared them to the category of traditional actively managed balanced funds. They summarize their findings as follows:

“Regardless of the test used, we found no excess returns, or alpha, on average, during the analysis period (January 1998 to June 2013). The majority of these funds underperformed, which contradicts the common assumption that a broader opportunity set translates into a higher likelihood of outperformance.”

The table below summarizes the median and the range of excess returns or alpha found under the five different evaluation methods.

As you can see, the returns are negatively skewed, meaning that an investor choosing a go-anywhere fund at the beginning of the 15.5 year period had a good chance of suffering a disappointing result. It is important to note that these results do not include the impact of survivorship bias, and it’s a fairly safe bet that the non-surviving funds had subpar performance, so our hypothetical investor’s odds were even more stacked against him.

While we normally associate a willingness to go anywhere with a strong sense of adventure, for the purpose of investing, it is just style drift, and there is no good reason to have it in your portfolio. Getting to your investment destination requires staying disciplined in a risk-appropriate asset allocation, and going anywhere is likely to get you nowhere.

 


1Shtekhman, Anatoly, Kimberly A. Stockton, and Brian R. Wimmer, 2014. Broader Opportunities, Same Limited Results: An Analysis of ‘Go-Anywhere Funds’. Valley Forge, PA: The Vanguard Group.