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A matter of style: The causes and consequences of style drift in institutional portfolios

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  • Wermers, Russ

Abstract

The equity style orientation of an institutional portfolio has a large influence on its yearly returns. This paper analyzes the causes and consequences of portfolio style drift among U.S. equity mutual funds by developing new portfolio holdings-based measures of drift. These holdingsbased measures allow a decomposition of style drift into components that result from active versus passive portfolio decisions by a fund manager in three different equity style dimensions: size, bookto-market, and price momentum. We find that a significant amount of style drift results from active manager trades, therefore, managers that trade more frequently tend to manage portfolios with greater style drift. In addition, managers of growth-oriented funds and small funds, and managers having good stockpicking track records, tend to have higher levels of style drift than other managers; these managers also deliver better future portfolio performance as a result of their trades, even after accounting for their higher trading costs. Consistent with this superior performance, managers do not seem to be concerned with controlling style drift; indeed, managers tend to be style chasers during most years, which appears to benefit their performance. Overall, our findings suggest that controlling the style drift of a fund manager does not necessarily result in higher performance for investors.

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  • Wermers, Russ, 2012. "A matter of style: The causes and consequences of style drift in institutional portfolios," CFR Working Papers 12-04, University of Cologne, Centre for Financial Research (CFR).
    • Handle: RePEc:zbw:cfrwps:1204
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    References listed on IDEAS

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    Cited by:

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    4. Gejadze, Maia & Giot, Pierre & Schwienbacher, Armin, 2017. "Private equity fundraising and firm specialization," The Quarterly Review of Economics and Finance, Elsevier, vol. 64(C), pages 259-274.
    5. Herrmann, Ulf & Scholz, Hendrik, 2013. "Short-term persistence in hybrid mutual fund performance: The role of style-shifting abilities," Journal of Banking & Finance, Elsevier, vol. 37(7), pages 2314-2328.
    6. Mark D. Flood & Phillip Monin, 2016. "Form PF and Hedge Funds: Risk-measurement Precision for Option Portfolios," Working Papers 16-02, Office of Financial Research, US Department of the Treasury.
    7. Li, Li & Huang, Shiyang & Lou, Dong & Shi, Jiahong, 2021. "Why don't most mutual funds short sell?," LSE Research Online Documents on Economics 118854, London School of Economics and Political Science, LSE Library.
    8. Huaizhi Chen & Lauren Cohen & Umit G. Gurun, 2021. "Don't Take Their Word for It: The Misclassification of Bond Mutual Funds," Journal of Finance, American Finance Association, vol. 76(4), pages 1699-1730, August.
    9. Wagner, Moritz & Margaritis, Dimitris, 2017. "All about fun(ds) in emerging markets? The case of equity mutual funds," Emerging Markets Review, Elsevier, vol. 33(C), pages 62-78.
    10. Bai, John Jianqiu & Tang, Yuehua & Wan, Chi & Yüksel, H. Zafer, 2022. "Fund manager skill in an era of globalization: Offshore concentration and fund performance," Journal of Financial Economics, Elsevier, vol. 145(2), pages 18-40.
    11. Cao, Charles & Iliev, Peter & Velthuis, Raisa, 2017. "Style drift: Evidence from small-cap mutual funds," Journal of Banking & Finance, Elsevier, vol. 78(C), pages 42-57.
    12. Herrmann, Ulf & Rohleder, Martin & Scholz, Hendrik, 2016. "Does style-shifting activity predict performance? Evidence from equity mutual funds," The Quarterly Review of Economics and Finance, Elsevier, vol. 59(C), pages 112-130.
    13. Luo, Deming & Yao, Zhongwei & Zhu, Yanjian, 2022. "Bubble-crash experience and investment styles of mutual fund managers," Journal of Corporate Finance, Elsevier, vol. 76(C).
    14. David R Gallagher & Peter A Gardner & Camille H Schmidt, 2015. "Style factor timing: An application to the portfolio holdings of US fund managers," Australian Journal of Management, Australian School of Business, vol. 40(2), pages 318-350, May.
    15. Chua, Angeline Kim Pei & Tam, On Kit, 2020. "The shrouded business of style drift in active mutual funds," Journal of Corporate Finance, Elsevier, vol. 64(C).
    16. Mark D. Flood & Phillip Monin & Lina Bandyopadhyay, 2015. "Gauging Form PF: Data Tolerances in Regulatory Reporting on Hedge Fund Risk Exposures," Working Papers 15-13, Office of Financial Research, US Department of the Treasury.
    17. Trapp, Monika & Wewel, Claudio, 2012. "Transatlantic systemic risk," CFR Working Papers 12-10, University of Cologne, Centre for Financial Research (CFR).
    18. Huaizhi Chen & Lauren Cohen & Umit Gurun, 2019. "Don’t Take Their Word For It: The Misclassification of Bond Mutual Funds," NBER Working Papers 26423, National Bureau of Economic Research, Inc.
    19. Sha, Yezhou, 2020. "The devil in the style: Mutual fund style drift, performance and common risk factors," Economic Modelling, Elsevier, vol. 86(C), pages 264-273.
    20. C. Wei Li & Ashish Tiwari & Lin Tong, 2017. "Investment Decisions Under Ambiguity: Evidence from Mutual Fund Investor Behavior," Management Science, INFORMS, vol. 63(8), pages 2509-2528, August.
    21. deHaan, Ed & Song, Yang & Xie, Chloe & Zhu, Christina, 2021. "Obfuscation in mutual funds," Journal of Accounting and Economics, Elsevier, vol. 72(2).
    22. Braun, Reiner & Jenkinson, Tim & Schemmerl, Christoph, 2020. "Adverse selection and the performance of private equity co-investments," Journal of Financial Economics, Elsevier, vol. 136(1), pages 44-62.
    23. Kempf, Alexander & Pütz, Alexander & Sonnenburg, Florian, 2012. "Fund manager duality: Impact on performance and investment behavior," CFR Working Papers 12-06, University of Cologne, Centre for Financial Research (CFR).
    24. Perez Katarzyna & Szczyt Małgorzata, 2021. "Classification of Open-End Investment Funds Using Artificial Neural Networks. The Case of Polish Equity Funds," Central European Economic Journal, Sciendo, vol. 8(55), pages 269-284, January.

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