While style drift may not be a mainstream financial term, it is something that every investor should be aware of. When you invest in actively managed funds, style drift can wreak havoc in your investment portfolio management, namely leading to poor asset allocation. So how do you avoid style drift and keep your risk tolerance in check?
What is Style Drift?
When your fund starts to take a detour from its original investment direction or style, that is style drift. In other words, the funds are not doing what you think they will.
Style drift can happen because of capital appreciation or when the fund’s management changes. It can also occur when a fund manager makes decisions outside of the investment objective.
When you invest in funds, you must state an objective. The parameters can be broad, as with privately managed funds (i.e. hedge funds), or rather strict as with registered funds (i.e. mutual funds). In fact, the SEC mandates that a fund invest 80% of its assets in investments directed by the fund name. The other 20% are the fund manager’s choice and more flexible.
For example, if you have a fund that normally doesn’t have tech stock, but then it subsequently invests in some tech stocks, you increase your exposure. Or if your fund manager picks some tech funds that are rapidly rising and your fund wasn’t originally intended to be heavily invested in tech, there could be overlap.
Is style drift a bad thing?
Asset Allocation Resulting from Style Drift
The negative effects of style drift range from decreased returns to funds that push legal boundaries. One of the greatest effects of style drift comes into play with your asset allocation.
Your portfolio is defined by how your investment holdings are distributed across all your investible assets. When your fund moves over time, or shifts, your asset allocation and risk tolerance also move. Usually not a in a preferable direction.
A good investment strategy is to build an asset allocation that is personalized to your specific risk tolerance. But if your fund manager sees a squirrel and veers off course, or isn’t watching your fund closely enough, your risk tolerance can derail.
And since no one can predict what the market will do, the fund diversions just add up to a bunch of randomness. Not what you had spent time planning and building. Not how you wanted your assets allocated.
The good news: style drift is avoidable. One option is to use passive funds, such as an index fund. Passive funds stay on track, keeping your exposure to risk in check.
If you opt for an active fund, there’s a lot more due diligence and research involved. Specifically, you’ll want to know the fund’s historical style drift to best predict what it could do in the future. Note that almost every active fund will have some degree of style drift – that’s the nature of the beast.
It’s important to remember that the goal of investment portfolio management is not to get the highest return. It’s to build a portfolio that helps you reach your specific objectives. Style drift is the exact opposite of that.
How Stableford Avoids Style Drift in Investment Portfolio Management
Simply put, you don’t want style drift in asset allocation. Consistency is always preferable. Stableford avoids style drift in our investment portfolio management through the construction of custom client solutions and because we are geographically and sector agnostic. Our strategies are backed by research, experience and knowledge. Additionally, the Stableford Leadership team are all active portfolio managers and strategists.
Consider this: S&P 500 has 13 different sectors, so you always have to have some allocation to some of those sectors. Large investment firms have so many managers that there is bound to be overlap.
There can also be delays in execution of changes. Most clients wouldn’t recognize that they were too heavily concentrated in one area until the exposure was revealed; until it was too late to protect against style drift.
As a privately-owned investment firm, Stableford is structured to minimize conflicts and focused on providing objective, unbiased advice. Fewer layers mean a more nimble execution of your investment goals. Our investment portfolio management strategies help us avoid style drift while aiming to provide you the asset allocation you prefer.
Are you ready to make portfolio changes or invest prudently? Contact Stableford today by calling 480.493.2300 or contact us online.