Most advisors and investors probably know that a mutual fund’s “style” has nothing to do with being fashionable. But what they may not know is how important it is for the funds they pick to stick to their style over the long term to help them reach their goals.
Mutual funds that stay true to their investment strategies help form the foundation of asset allocation success. But not all funds stay true to their name, which can play havoc with the asset allocation strategy of an investor’s portfolio.
In building a portfolio, each mutual fund you select represents a piece in the asset allocation puzzle that together should provide the best opportunity to meet your long-term investment objectives.
Collectively, these pieces determine how the portfolio may perform from both a return and a risk perspective over time. However, these funds could derail your asset allocation if the portfolio managers succumb to “style drift,” which happens when a fund’s underlying investments stray from their defined universe.
Style drift can occur in many ways. For example, a small-cap fund may “drift” into the mid-cap space when a manager hangs onto the winners in the portfolio for too long.
The style drift could also be more intentional, such as when a certain investment type is out of favor and the fund manager chases other investments to try to capture better returns or moves into a much higher level of cash in the portfolio. Or it could be a fixed-income manager who exposes the fund to more risk by moving further out on the duration spectrum or into lower quality credit to try to capture better returns.
The industry also has many “go anywhere” mutual funds that aren’t bound by a particular style but will fall into a certain Morningstar or Lipper category at any given time based on their underlying holdings.
However, you can’t assume that just because a fund is categorized today as a large-cap value fund that it will provide that type of exposure going forward. Therefore, when you are considering funds for a portfolio, you can’t necessarily rely solely on fund names, current holdings or stated investment styles.