Morningstar Advisor - Winter 2008 - (Page 41) “More style-consistent funds tend to produce higher total and relative returns than less consistent funds.” It is understandable that Brown and Harlow might reach a different conclusion that did Wermers, even though each’s time period largely overlapped. Brown and Harlow used yet another method of calculating style drift. Thus, instead of a single paper that unambiguously demonstrates a link between conforming to Morningstar’s style definitions and weaker performance, there are two papers that have only an ambiguous relationship to Morningstar’s work, and which arrive at directly opposite conclusions. Never mind the existence of several other papers that also touch on the matter peripherally and not necessarily on the side of flexible managers. For example, a paper published in Review of Financial Studies (“On Mutual Fund Investment Styles,” Chan, Chan, Lakonishok, 2002) found that funds that have style drift tend to do so after experiencing poor performance. The Limitations of General Studies Fund A Fund B Fund A moves to Large Growth Fund B has more portfolio changes but remains Large Blend. Value Blend Growth This caveat holds even if the study uses exactly the same methodology as does Morningstar for style drift, but does not directly measure whether a fund crosses from one style square to the next. Consider, for example, two imaginatively named investments, Fund A and Fund B. Both funds share the same portfolio and land in the northeast corner large-blend square of the style box, bordering the boundary with the large-growth segment and having a giant-cap flavor, placing far from the dividing line between large and mid-cap. Such is the map of a blend fund that tilts toward growth and that owns mostly market giants. Now assume that Fund A makes a couple of small trades, swapping two value stocks for growth stocks, such that it creeps across the boundary into large growth. Fund B, meanwhile, is run by a radical who turns over 50% of the portfolio, trading the large-cap blend and growth stocks for mid-cap value stocks. Fund B shifts down and to the left under Morningstar’s system, from the northeast corner of the large-blend square to the southwest corner. Which was the only fund to move between style-box squares according to the Morningstar’s style box classification? Fund A. Which fund almost certainly moved the most by other definitions of style drift? Fund B. The problem is clear: The methods determine the answers. That is, different approaches for style classification, and different measurements of style drift, result in such dramatically different outcomes that one cannot generalize from the studies. It is not possible to translate 08 This is what we can say. First, even in general terms the academic research on the alleged superiority of flexible managers is mixed. Brandishing one of these academic papers, ignoring the others, and pretending that the answer lies in favor of style-flexible managers will often convince seminar audiences who are understandably unfamiliar with the details of the subject—but convincing is not the same as being correct. Second, even if the academic research could be considered settled, it is unclear if such research could address the specific topic of funds moving among Morningstar’s style squares. Funds that show high levels of style drift by one methodology might have been style tortoises by Morningstar’s measurements, while funds that show low levels of drift might have bounced around the Morningstar style squares. It is not possible to use other measures of style consistency to predict how a fund would have been depicted by Morningstar. Save the Date June 25–27, 2008. Join us for the 20th annual Morningstar Investment Conference located at the McCormick Place, West Building, in Chicago. 2 0 Large Mid Small Save the Date Register Today Register before February 29, 2008 to take advantage of the early bird rate. Call us at 866 839-9729, or visit us online: advisor.morningstar.com/2008conference ©2008 Morningstar. All rights reserved. The Morningstar name and logo are registered marks of Morningstar. Marks used in conjunction with Morningstar products or services are the property of Morningstar or its subsidiaries. All other marks are the property of their respective owners. Product specifications are subject to change without notice. MorningstarAdvisor.com 41 http://advisor.morningstar.com/2008conference http://MorningstarAdvisor.com
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