Morningstar Advisor - Winter 2008 - 40

Spotlight Fashion Change By John Rekenthaler Praising “flexible” managers is now all the rage. But where is the evidence supporting the style-box hoppers? How the world has turned. A decade ago, stock-fund managers boasted of their “style purity”—implying that funds that placed within a single square of Morningstar’s equity style box would outperform allegedly undisciplined funds that “drifted” from square to square. Fund companies boasted about their hard-nosed discipline, of the toughness and experience that was required to learn one investment arena very well and to invest in that space thoroughly. Fund consultants fashioned themselves as “style police,” hunting down miscreants. Today, the opposite argument holds sway. Style-pure managers are in retreat, under attack from critics who have renamed their funds as “style constrained.” Conversely, the once-reviled style drifters have, like John Travolta, benefited from an image makeover. They are no longer aimless wanderers; instead, they are “flexible.” Well, that’s different, isn’t it? Nobody likes drifters; they drink cheap liquor from paper bags and harass pregnant moms. Flexible, on the other hand, signals a practical, friendly chap. Helping the flexible managers’ brand has been a series of articles and presentations claiming superior returns for style-drifting—err, I mean style-flexible— managers. In a survey of the subject, American Funds’ Winter 2008 Insights writes, “Research indicates that managers constrained by style boxes underperformed those with a broader mandate that allows them to invest in a more flexible manner.” Put more bluntly, funds that stay within a single style-box square tend to lag the hoppers. With due respect to American Funds, which is a highly reputable, quality organization, that statement is not correct. Research does not indicate whether funds that move from one square of the Morningstar Style Box to another are in aggregate superior to funds that remain in a single style square. Research does not indicate if you should be happy, sad, or indifferent in owning flexible managers. Research is silent. Next issue of Morningstar Advisor, we’ll unveil studies that directly tackle the relevant issue: Should you care if a fund moves within the style box? In the meantime, it’s worth reviewing the existing literature. Clearly, there are misperceptions about what we actually know about the effects of style boxes on fund managers. Similar Studies, Opposite Findings greater amounts of “style drift,” according to Wermers’ measurement, outgained the “low-drift” managers by as much as 300 basis points per year. The Wermers paper was notable for taking the difficult, data-intensive route of measuring style drift by looking at individual portfolio holdings. Most academic studies use returns-based analysis, which is a less direct measurement system, and arguably less accurate, but which has the virtue of being much more easily generated. The Wermers paper has become something of a calling card for those who claim that mutual fund managers are hurt by staying within a single square of the style box. However, as the Wermers paper measures style differently than does Morningstar—most notably, by including stock momentum as a style element—and does not attempt to determine at what point if any that a Wermers’ drifting fund would move to a different Morningstar style square, it is not possible to use the Wermers results to draw a lesson about Morningstar data. The calling card has the wrong address. Also, in 2001 another professor—Keith Brown of the University of Texas, who was coauthor with Van Harlow of Fidelity—released an unpublished paper that covered the same subject, over a 12-year time period, and reached precisely the opposite finding: The story begins with an unpublished paper from 2002 by Russ Wermers, associate professor of finance at the University of Maryland-College Park, that found that over a 15-year period, stock fund managers who had 40 Morningstar Advisor Winter 2008

Morningstar Advisor - Winter 2008

Table of Contents for the Digital Edition of Morningstar Advisor - Winter 2008

Morningstar Advisor - Winter 2008
Contents
Letter from the Editor
Inbox
How Do You Use the Morningstar Style Box?
Real Estate Investing Goes Global
The Golden Touch
Investment Briefs
Learning to Fly with Equity Options
Another Block in Building a Portfolio
In a League of Their Own
Unlock the Box
Fashion Change
The View from the Investment Side
Unpredictable Style
Weighting the Fundamentals
Wire-to-Wire Consistency
The Secret's Out
Focus on Financials
Strongest Homebuilders Will Withstand the Wrecking Ball
Breaking Style Conventions
Playing It Safe with Financials
Back to Bond School
Mutual Fund Analyst Picks
Undervalued Stocks
Most Popular Variable Annuities
New at Morningstar
The Style Counsel
Morningstar Advisor - Winter 2008 - Intro
Morningstar Advisor - Winter 2008 - Morningstar Advisor - Winter 2008
Morningstar Advisor - Winter 2008 - Cover2
Morningstar Advisor - Winter 2008 - 1
Morningstar Advisor - Winter 2008 - 2
Morningstar Advisor - Winter 2008 - Contents
Morningstar Advisor - Winter 2008 - 4
Morningstar Advisor - Winter 2008 - 5
Morningstar Advisor - Winter 2008 - 6
Morningstar Advisor - Winter 2008 - Letter from the Editor
Morningstar Advisor - Winter 2008 - 8
Morningstar Advisor - Winter 2008 - Inbox
Morningstar Advisor - Winter 2008 - How Do You Use the Morningstar Style Box?
Morningstar Advisor - Winter 2008 - 11
Morningstar Advisor - Winter 2008 - Real Estate Investing Goes Global
Morningstar Advisor - Winter 2008 - 13
Morningstar Advisor - Winter 2008 - 14
Morningstar Advisor - Winter 2008 - The Golden Touch
Morningstar Advisor - Winter 2008 - 16
Morningstar Advisor - Winter 2008 - 17
Morningstar Advisor - Winter 2008 - Investment Briefs
Morningstar Advisor - Winter 2008 - 19
Morningstar Advisor - Winter 2008 - 20
Morningstar Advisor - Winter 2008 - 21
Morningstar Advisor - Winter 2008 - Learning to Fly with Equity Options
Morningstar Advisor - Winter 2008 - 23
Morningstar Advisor - Winter 2008 - 24
Morningstar Advisor - Winter 2008 - 25
Morningstar Advisor - Winter 2008 - Another Block in Building a Portfolio
Morningstar Advisor - Winter 2008 - 27
Morningstar Advisor - Winter 2008 - 28
Morningstar Advisor - Winter 2008 - 29
Morningstar Advisor - Winter 2008 - In a League of Their Own
Morningstar Advisor - Winter 2008 - 31
Morningstar Advisor - Winter 2008 - 32
Morningstar Advisor - Winter 2008 - 33
Morningstar Advisor - Winter 2008 - 34
Morningstar Advisor - Winter 2008 - 35
Morningstar Advisor - Winter 2008 - Unlock the Box
Morningstar Advisor - Winter 2008 - 37
Morningstar Advisor - Winter 2008 - 38
Morningstar Advisor - Winter 2008 - 39
Morningstar Advisor - Winter 2008 - Fashion Change
Morningstar Advisor - Winter 2008 - 41
Morningstar Advisor - Winter 2008 - 42
Morningstar Advisor - Winter 2008 - 43
Morningstar Advisor - Winter 2008 - The View from the Investment Side
Morningstar Advisor - Winter 2008 - 45
Morningstar Advisor - Winter 2008 - 46
Morningstar Advisor - Winter 2008 - 47
Morningstar Advisor - Winter 2008 - 48
Morningstar Advisor - Winter 2008 - 49
Morningstar Advisor - Winter 2008 - 50
Morningstar Advisor - Winter 2008 - 51
Morningstar Advisor - Winter 2008 - Unpredictable Style
Morningstar Advisor - Winter 2008 - 53
Morningstar Advisor - Winter 2008 - Weighting the Fundamentals
Morningstar Advisor - Winter 2008 - 55
Morningstar Advisor - Winter 2008 - 56
Morningstar Advisor - Winter 2008 - 57
Morningstar Advisor - Winter 2008 - 58
Morningstar Advisor - Winter 2008 - 59
Morningstar Advisor - Winter 2008 - 60
Morningstar Advisor - Winter 2008 - 61
Morningstar Advisor - Winter 2008 - Wire-to-Wire Consistency
Morningstar Advisor - Winter 2008 - 63
Morningstar Advisor - Winter 2008 - 64
Morningstar Advisor - Winter 2008 - 65
Morningstar Advisor - Winter 2008 - The Secret's Out
Morningstar Advisor - Winter 2008 - 67
Morningstar Advisor - Winter 2008 - 68
Morningstar Advisor - Winter 2008 - 69
Morningstar Advisor - Winter 2008 - Focus on Financials
Morningstar Advisor - Winter 2008 - 71
Morningstar Advisor - Winter 2008 - 72
Morningstar Advisor - Winter 2008 - 73
Morningstar Advisor - Winter 2008 - Strongest Homebuilders Will Withstand the Wrecking Ball
Morningstar Advisor - Winter 2008 - 75
Morningstar Advisor - Winter 2008 - Breaking Style Conventions
Morningstar Advisor - Winter 2008 - 77
Morningstar Advisor - Winter 2008 - Playing It Safe with Financials
Morningstar Advisor - Winter 2008 - 79
Morningstar Advisor - Winter 2008 - 80
Morningstar Advisor - Winter 2008 - Back to Bond School
Morningstar Advisor - Winter 2008 - 82
Morningstar Advisor - Winter 2008 - Mutual Fund Analyst Picks
Morningstar Advisor - Winter 2008 - 84
Morningstar Advisor - Winter 2008 - 85
Morningstar Advisor - Winter 2008 - 86
Morningstar Advisor - Winter 2008 - 87
Morningstar Advisor - Winter 2008 - Undervalued Stocks
Morningstar Advisor - Winter 2008 - 89
Morningstar Advisor - Winter 2008 - 90
Morningstar Advisor - Winter 2008 - 91
Morningstar Advisor - Winter 2008 - Most Popular Variable Annuities
Morningstar Advisor - Winter 2008 - 93
Morningstar Advisor - Winter 2008 - New at Morningstar
Morningstar Advisor - Winter 2008 - 95
Morningstar Advisor - Winter 2008 - The Style Counsel
Morningstar Advisor - Winter 2008 - Cover3
Morningstar Advisor - Winter 2008 - Cover4
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