Why 'style drift' is a red flag when it comes to investing


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An important term for investors to be aware of is "style drift", where fund managers move away from their stated investment style or broad investment parameters to find better short-term returns for their investors.

Investors must be clear about their investment strategy, their mix of managers and what they are looking for from their managers, particularly if they have made a choice based on investment style.

There will be times when the best money managers in the world - as judged by various market metrics - are battered by market movements and when they underperform the temptation will be strong for them to invest in opportunities that go against their stated objectives to take advantage of short-term market sentiment.

There will be times when the best money managers in the world, battered by market movements, are tempted to abandon their objectives. This is style drift.

For example, a growth-style manager, seeing their growth assets under pressure as future growth is heavily discounted by investors, consider buying value stocks to improve their performance.

While this style drift may create a short-term benefit, chasing what is in vogue usually doesn't produce the expected outcome and the long-term consequences may be significant. Value stocks appearing in a growth portfolio would be cause for concern.

For individual investors, keeping track of a fund manager's adherence to their stated style is worth the effort of additional research.

For instance, always read the monthly report to understand why the manager has made certain investment decisions and what has contributed to performance (or underperformance).

Analytics on managers that may contain "style snail trails" are also extremely useful in this regard.

If you are invested in a fund manager and the fund is performing badly relative to the market, it is important to consider the underlying reasons for that under-performance.

If it is a "black swan" or unexpected economic event - such as the UK's decision to the leave the European Union, a country defaulting on its debt repayments or the election of an unpopular president - then probably no further evaluation is necessary.

However, if the manager is underperforming other managers in the same style cohort, then further evaluation is clearly necessary.

Staying the course means ensuring you are with the right manager in the first place. But if the manager is still investing in the way that was promised and is still on track for the long-term returns expected, investors should think carefully about any decision to exit especially when the markets are extremely volatile.

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