Wealth Management & Financial Planning

Wealth Management & Financial Planning

Investment Style Misclassification

Equity mutual funds are classified by style and size. Each fund is classified by the prospectus where investors receive the expectation of the managers investment selections. Style refers to the primary objective of the holdings inside of the fund. Size refers to the market capitalization of the main holdings. Portfolios can and do move from the original objective overtime. This is referred to as style drift. 

Style is separating growth-oriented companies from value driven stocks. When a person you know typically wears the same style of wardrobe (think casual or suit and tie person), you have an expectation of how they will appear each time you meet. What happens when the suit and tie guy suddenly emerges in a tie dye shirt? You are surprised because the style simply doesn’t fit your expectation. This is referred to as “style drift in the mutual fund world. 

Growth is one style classification. Though not always the case, growth stocks have certain characteristics.  Most commonly Growth stocks are reinvested in growing the business more than paying dividends to stockholders. They also tend to be more volatile over time and typically trade at a higher price to earnings ratio or multiple than the total market does. People who invest in growth expect those characteristics and accept the nature or risk of the potential reward. 

Value stocks generally have the opposite characteristics. They do usually pay dividends and they are typically less volatile. Investors buy value driven stocks when they believe the value of the existing company is fairly reflected in the current stock price. Growth oriented investors are buying the stock today based on what they believe the company could become. 

Size refers to market capitalization. The formula to determine size is simple: one share of the company’s current stock price multiplied by the number of shares of stock outstanding. Note that the number of shares issued by individual companies varies from the millions of shares to billions. A stock price alone does not express the size of the company.  Outstanding share count is required to know the size. 

There have been traditionally large cap, mid cap and small cap funds based on market capitalization.  Mega and micro cap have been introduced over time. 401k’s offer the three primary options and most likely an international fund along with bond and cash options. 

Because you do not know what the manager owns within a Mutual Fund, they are not considered to be transparent. The Securities and Exchange Commission (SEC) does their best to monitor style drifting but the lack of transparency in mutual funds makes it a daunting task. 

Let’s assume you want to have 30% of your account in growth oriented funds and 30% in value based investing. In the last decade, growth has trounced value. This is common knowledge among professional money mangers. In some cases, value oriented funds have drifted towards growth in search of higher returns. This undermines your desire for diversification and should be unacceptable.  

The human mind can rationalize many things and money managers are not excluded. Explanations for style drift can be laughable. The potential impact to your retirement isn’t as amusing. 


Disclaimer: Joseph Clark is a Certified Financial Planner™ and the Managing Partner of Financial Enhancement Group, LLC an SEC Registered Investment Advisor. He is the host of “Consider This” found on WIBC Saturday mornings from 6-7a.m. as well as three other Indiana-based radio stations. Joe has served as an Adjunct Assistant Professor at Purdue University where he taught the capstone course for a degree in Financial Counseling and Planning. 

Financial Enhancement Group is an SEC Registered Investment Advisor.  Securities offered through World Equity Group, Inc., Member FINRA/SIPC, and a Registered Investment Advisor.  Investment Advisory services offered through Financial Enhancement Group (FEG) or World Equity Group.  FEG is not owned or controlled by World Equity Group. 

Joseph Clark and World Equity Group, Inc. do not provide tax or legal advice. For tax advice consult with a qualified tax professional. For legal advice consult with an attorney. 

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