“On the ninth day of Christmas my broker gave to me…9 styles drifting”

If anyone has gone to the Morningstar website, or has even heard of the company there is something called a “style box” that you can view. It looks exactly like a tic-tac-toe game.

This box gives you an idea of what the average capitalization of a mutual fund is, and whether it is a growth or value type of mutual fund. On the right hand side you see that the top 3 boxes are for large companies, the middle 3 boxes are medium sized companies, and the bottom 3 boxes are for small companies. The bottom of the boxes help to tell us whether the fund tends to hold more of value type of securities, (boxes on the left) or more growth type companies (boxes on the right). We are not going to discuss the difference between the different types of securities today; we just want to understand the concept.

The box on the top left tells us that the mutual fund holds mostly Large-Value companies inside the portfolio. The box on the bottom right tells us that the fund will hold mostly Small-Growth companies. This helps when creating a portfolio. You want to know what your funds hold which help to ascertain the volatility within the portfolio itself.

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 mutual fund might state that it is a Small-Growth mutual fund, so it should be in that bottom right hand side of the box, but when we look at the average security in the fund, the box has “drifted” from the bottom right, to the bottom left. This tells us that the mutual fund has become more of a Small-Value fund.

You may be wondering why this is important. When you are trying to control the volatility in the portfolio, you need to know what you own. You may be a long-term investor with a certain risk tolerance, but the active mutual fund manager can effectively just create a more or less risky portfolio due to his drifting. If you hold a Small Growth fund, you are holding it for the specific purpose of needing that asset class in your portfolio. If the fund drifts toward value, that creates a more risky portfolio due to higher ups and downs. You need to know WHAT you own and WHY you own it. If you don’t then perhaps you need someone to help educate you about these concepts.

Philip A. Guske