Morningstar Advisor - Winter 2008 - 80

Case Study | Morningstar DirectSM Investment Style Analysis: Which Side Are You On? Although investment style analysis is widely regarded as a valuable exercise, there is much debate about exactly how style should be measured. What’s Your Style? Equity style analysis is a method used to identify and describe the characteristics of an investment portfolio. Institutional investors and consultants use style analysis to purchase, classify, or construct managed investments and monitor them for style drift. Style analysis is also used to construct peer groups and to select appropriate style-specific benchmarks. Two Approaches, One Objective The studies also indicate that holdings-based style analysis with a portfolio that is one year old produces better results than does returns-based analysis with current data. Furthermore, holdings-based analysis is more stable and consistent over time and therefore provides a better estimate of a portfolio’s future style and risk. To read the research papers, visit http://global. morningstar.com/DirectCaseStudies. The Bottom Line Morningstar Direct Capabilities Peer Analysis Compare a full set of data points and search across investment types for precise benchmarking. Performance Evaluation Analyze thousands of discrete data points, including a range of customizable performance and risk statistics. Stock and Ownership Analysis Examine stock ownership trends within the portfolios of hedge funds, mutual funds, separate accounts, and institutional money managers. Output Generate professional reports, charts, and data tables. Data Universes Explore comprehensive information on open-end, closed-end, and exchangetraded funds; hedge funds, separate accounts; U.S. variable annuities and stocks; stock ownership; and market indexes. Learn More To see how Morningstar Direct uses skewness and kurtosis statistics to analyze a typical hedge fund, visit http://global.morningstar.com/ DirectCaseStudies Risk-Free Trial Contact us today for a one-on-one demonstration and a 15-day trial to Morningstar Direct. 3 +1 866 229 0216 3 MorningstarDirect@morningstar.com 3 http://global.morningstar.com/MorningstarDirect There are two main types of style analysis: holdings- and returns-based. Holdings-based style tools classify portfolios based on the underlying securities. Returnsbased style analysis compares the portfolio’s total returns relative to the total returns of various style-based indexes to make inferences based on how closely the portfolio returns resemble those indexes. Returns-based style analysis has been more widely used because the monthly returns data is readily available. The holdings-based approach has been wellreceived in concept but difficult to apply, because fewer people have access to portfolio holdings data. Separate Yet Equal? A solid understanding of the strengths and limitations of style analysis models will aid in interpreting results. The Morningstar studies concluded that holdingsbased style analysis generally produces more accurate results. However, in certain circumstances, returnsbased style analysis can be used to estimate investment style. Ideally, both approaches should be put to use; returns-based models can often be more widely applied while holdings-based models allow for deeper style analysis. Both methodologies are available in Morningstar Direct. Examine and Communicate Investment Style Using Morningstar Direct Many institutional investors use only one method of style analysis, and researchers at Morningstar wanted to determine if the methods were fair substitutes for each other. We conducted two separate studies to evaluate each approach. The studies show that returns-based style analysis generates similar results to holdings-based analysis for large-cap and value-oriented portfolios. However, significant variation occurs between the two methods for small- and mid-cap, and growth-oriented funds. Furthermore, statistics such as R-squared from the returns-based model can sometimes imply more accuracy than is present. Morningstar Direct is a global institutional research platform that provides in-depth performance and holdings analysis of investments. Institutions worldwide use Morningstar Direct to develop, select, and monitor investments that meet investors’ needs. This Web-based solution unites powerful analytics with the most timely, comprehensive Morningstar investment data and research available. Continuous data updates fuel rigorous research for product development, competitive analysis, marketing, investment selection, and performance evaluation. Use both holdings- and returnsbased style methodologies in Morningstar Direct to analyze style trends and create meaningful reports. ©2007 Morningstar, Inc. 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.

http://global.morningstar.com/DirectCaseStudies http://global.morningstar.com/DirectCaseStudies http://global.morningstar.com/DirectCaseStudies http://global.morningstar.com/DirectCaseStudies http://global.morningstar.com/MorningstarDirect http://global.morningstar.com/MorningstarDirect

Morningstar Advisor - Winter 2008

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