Don't Let Style Drift Hinder Your Investment Objectives

Many investment experts stress the importance of portfolio diversification. After all, diversification can help to add a measure of balance to a portfolio, which helps to reduce the portfolio's market volatility risk (although it doesn't guarantee against the risk of loss in a declining market).

Unfortunately, adequate diversification can be difficult to achieve if the mutual funds you own drift from their stated investment mission. This "style drift" can occur gradually over time, as would be the case if a manager of a small-company fund started to buy securities of larger companies as his fund asset base grows. It can also occur abruptly if a manager perceives opportunities for higher returns from a different asset class.

Style drift can create a variety of problems. For one, it can keep you from maintaining reliable asset class allocations for your portfolio, which could prevent you from reducing your market-volatility risk. This can result in an inconsistent exposure to market risk, and can potentially result an unexpected change in the returns of your investments. Furthermore, to rebalance the portfolio back to expected risk and return levels, unnecessary costs and taxes might be incurred to maintain or preserve consistency in your portfolio's asset allocation.

Policing style drift is a hot topic these days. That's especially true given the blurring of lines between growth and value. Indeed, some investments considered to be growth companies today were considered value companies in the past, and vice versa. For example, energy was historically considered as a value investment. Today, given current world demand, it can arguably be considered as growth investment, which is why you could find a high concentration of energy stocks in both your value and growth funds. Although this observation might not hold true for every fund, if it happens- it can potentially negate some of the diversification benefits of combining the two styles.

Also, The considerable latitude given to active managers by some mutual fund prospectuses can also result in style drift. On the other hand, this result can sometimes be countered with pure index funds, because of their more clearly defined rules and their traditional dedication to an investing benchmark. That said, if you are considering an investment in any type of mutual fund, you should carefully consider the fund's investment objectives, as well as its relative risks, charges and expenses before investing.

I always advise people to consult with their own qualified legal, tax, and financial advisor prior to making any financial decisions. Please carefully consider investment objectives, risks, charges, and expenses before investing. For this and other information about any mutual fund investment please call the funds provider to request a prospectus. Please read it carefully before you invest.

Want to know more about style drift, its potential implications, and how to monitor it?

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