Investors need to be aware of the effects of "style drift"of funds they hold in their portfolios, warns Don Williams, chief investment manager at Platypus Asset Management.
"Style drift"is the divergence of a fund from its stated investment style. It can have an unrecognised but very real impact on risk exposure for investors.
"Investors may not be aware that a fund they have invested in has diverged from its stated style, but it does matter. This is one of the benefits an adviser brings to their clients, as they are more likely to know those asset managers who are committed to being true-to-label.
"Style drift generally occurs as a result of intentional portfolio investment decisions, or sometimes a change of the fund's management. It can also be caused by managers who are chasing short-term performance and tempted to switch to a strategy that is expected to outperform in the short term,"Mr Williams said.
"Style drift can also happen unintentionally. For example, style drift across market capitalisation can occur for small cap funds when the market is rising and the fund's stocks are growing. Funds that employ "buy and hold"strategies are also likely to experience style drift from market capitalisation.
"Less common is the drift across investment styles, such as a growth manager increasing their holdings in value or core stocks rather than remaining invested in growth stocks."
Mr Williams said the main danger of style drift is that it alters risk exposure.
"If a manager intentionally modifies their investment style as they chase short-term returns, it can change the overall risk return profile of a client's portfolio.
"For investors a result of this can be that, instead of having a blend of styles and therefore diversified risk, a portfolio can end up with a blend of managers with consistent styles and risk exposures that perform similarly in market conditions.
"While this may result in short-term gains, it can be detrimental to the long-term risk return profile and performance of the portfolio.
"In addition, if managers mistime their shift in style, investors' overall portfolios will suffer as they will be over-exposed to the wrong style for the market conditions.
"Investors diversify their fund styles for a good reason. Style drift unwinds investor intentions at a portfolio level without their knowledge.
"Given the impact on the risk exposure of a portfolio, style drift is a key reason for advisers to review portfolios with clients, and potentially re-allocate funds and asset managers,"he said.
Mr Williams said the simplest way to check for style drift is to check the fund’s holdings for:
- a change in company size
- a significant shift in sector weighting, or
- a decrease in correlation of a fund’s performance with a stated style index.
"More sophisticated approaches using numerical measures of style drift can also be used to classify a portfolio’s style and history," he said.
Platypus Asset Management is a specialist boutique investment manager founded in 1998. Its investment approach focuses on identifying high quality Australian companies with strong future growth prospects. The business formed a joint venture with Australian Unity in 2006.