For many years now, one of the major problems with mutual funds – and even independent investment managers – is the issue of style drift. This really is a symptom of "chasing returns" which one might expect to see caused more by the investing public than the professionals, but, as we have seen over the years, professionals are no more immune and just as emotionally and greed/fear driven as the great unwashed.

Briefly, style drift can be described as when the stated objectives of a portfolio – whether individual, institutional or an investment fund (think mutual funds) – are abandoned in the pursuit of gains by adding supposedly "hot stocks" or sectors to it. Thus, when a "value" orientation is abandoned by adding a hyper growth stock to the portfolio or a "dividend" paying orientation is abandoned similarly by a stock that doesn't pay dividends, style drift is said to have occurred – in other words, "drifting" away from the original objective and orientation of the portfolio.

This occurrence is important because when engineering the construction of a portfolio -- particularly following the tenets of Modern Portfolio Theory, a manager uses various, non-correlated asset classes to accomplish the portfolio objectives. When individual stocks are added to these portfolios, by these managers, in pursuit of additional gains, the purity of the asset class exposure is tarnished and, ultimately, what is expected from the original construction, likely will not be realized.

We saw a great deal of this exhibited in the late 90's - early 2000's during the tech and dot.com era when every conceivable type of fund or portfolio was corrupted by the addition of tech, growth and dot.com stocks. Similarly, even today, we see the reemergence of this phenomena. In an issue of Investment News, around the time Facebook went public, their editorial pointed out the following:

"Facebook's initial public offering revealed more than the fact that a hot company need not necessarily be a hot stock. As the Wall Street Journal reported, a surprisingly diverse group of mutual funds lined up for Facebook Inc's shares. More surprisingly and potentially disturbing for financial advisors and their clients is that many of the funds, given their ostensible investment goals, shouldn't have bought the stock at all.

For example, a dividend growth fund bought Facebook shares even though the company doesn't pay a dividend.

Additionally, a good number of value funds bought shares even though Facebook isn't considered a value stock...

Too much style drift is an indication that a fund's manager, or managers have veered away from a fund's stated objectives...."

This is one of the more important reasons that we utilize the funds that we do -- for their purity in remaining true to their stated objectives. This enables the engineering of a portfolio without having the fear of style drift occurring, which would change the long-term designed course and potentially cause a client to miss attaining stated portfolio objectives!

Copyright © 2012 – 2019
Frederick C. Taylor
All Rights Reserved

Before going on to other matters, let me provide a brief example as to why the knowledge and understanding of history is so important -- particularly as it relates to investing. Currently, we are viewing mass demonstrations (justified or otherwise) which the media is treating as some sort of new phenomena as if problems on Wall Street had never been experienced before.

Benjamin Graham, one of the wisest sages ever to teach and write about finance had these interesting observations about the scandalous behavior, lack of ethics and speculation unbounded to be found on Wall Street (note the date of the writing at the end [(btw, Graham was Buffet's finance professor and the man who taught him everything that he knows about investing!]).

“I think the future of equities will be roughly the same as their past; in particular, common-stock purchases will prove satisfactory when made at appropriate price levels. It may be objected that it is far too cursory and superficial a conclusion; that it fails to take into account the new factors and problems that have entered the economic picture in recent years — especially those of ... the movement towards less consumption and zero growth. Perhaps I should add to my list the widespread public mistrust of Wall Street as a whole, engendered by its well-nigh scandalous behavior during recent years in the areas of ethics, financial practices of all sorts, and plain business sense.”

— Excerpt from June 1974 speech
by Benjamin Graham, printed in Financial Analyst
Journal, September/October 1974

Sound familiar? The more things change, the more they stay the same!!

Copyright © 2012-2019
Frederick C. Taylor
All Rights Reserved