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Beware ‘style drift’ – one of professional investing’s disqualifying offences

08/12/2016

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

Some people apparently just will not be told. Whilst past performance is no guide to the future, despite all the evidence a value-based approach has outperformed over time, investors’ money is increasingly clustering in more non-value-oriented offerings – sometimes known as ‘growth’ but probably more accurately called ‘momentum’ funds. The current situation is starkly illustrated by the following chart, which we showed you the other day in How style can equal substance.

 

Source: Schroders, Morningstar Direct, based on Morningstar UK domiciled funds using fund data available at 31 May 2016.

 

As we explained then, data provider Morningstar analysed its 1,100-strong universe of UK portfolios and found just 9% of the £500bn-odd under management within it could be said to be in funds that have a value style of investing – defined as having a greater than 50% bias to value. We also noted that, a decade ago, the split was closer to 40/60 so, given all that evidence value has outperformed over time, how has it come to this?                                   

The first and perhaps most obvious reason, which we highlighted earlier this week in Two charts, is that value has – until quite recently – had a pretty torrid time of it for the best part of a decade. That means, if you were a professional investor exposed to value, you will have underperformed – and, if you had less enlightened employers than we have here on The Value Perspective, your fund may have been closed or merged away.

Alternatively, you may have been fired – in which case, your replacement is unlikely to have concluded the most sensible strategy was to continue to invest in exactly the same way that saw their predecessor lose their job. In which case, they will have consciously and deliberately shifted the emphasis of their portfolio – essentially moving it further to the right of the above chart.

A second reason for that 9% share in UK funds under management is a recognition by professional investors that value has not been working – and this too, you would think, is largely deliberate. Mostly these managers could be considered ‘style-agnostic’ and they would have decided to tilt their portfolios away from value and towards momentum because that was what was working and what had been driving performance.

At this point, it is worth highlighting that a portion of the shift from a 40/60 share to 9/91 will simply be down to performance. Remember – the above chart is based on assets under management so, if as a manager you had maintained your value exposure, you would have underperformed the more growth-oriented funds and the split would have become more pronounced even if every other factor had remained the same. This would have been further accentuated by the flows of investor money that tend to follow periods of disparate short-term performance – with money heading out of funds doing poorly(value) and into those doing well (momentum).                                                          

The final reason for the decline in value-biased portfolios is the most pernicious and, for that reason, the one investors most need to watch out for. This would have involved fund managers unconsciously shifting to the right of the above chart because, on the one hand, they would have grown comfortable with the stocks they owned, which would have been increasing in value and, by definition, becoming more momentum in nature.

At the same time, these managers would have found the sort of businesses that would have kept their portfolios further to the left of the chart – the retailers, the banks, the miners or whatever else has been deeply unloved at some point over the last 10 years – thoroughly unappealing. As such, they would gradually have suffered what is known as ‘style drift’.

And if you do not mind your fund manager veering across the style charts like a really slow drunk-driver, then that is fine. For those investors, however, who select their fund managers to fulfil a specific role in order to achieve a desired outcome or deliver a particular kind of return, then style drift – be it subconscious or otherwise – to our minds isn’t simply a ‘points’ offence. It should be licence lost.

Whatever style of manager you are after, make sure you pick one who gets you where you want to go by the route you wanted them to take.

Author

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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The views and opinions displayed are those of Ian Kelly, Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans and Simon Adler, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated. They do not necessarily represent views expressed or reflected in other Schroders' communications, strategies or funds. The Team has expressed its own views and opinions on this website and these may change.

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