Last week we ran across an interesting Forbes story on the positive utility of mutual fund style drift in which Joshua Lipton argues that relatively unconstrained money managers tend to outperform their boxed-in competitors--and thus that investors should actually welcome style drift rather than fight it. This mildly contrarian take leads us back to an argument we've made repeatedly (in April and July, for instance).
We think investors' and advisors' determination to fit mutual funds into "style boxes" imposes unhelpful constraints on money managers and--more importantly--reflects a fundamental misconception of prudent return-seeking in a risk-management (and expense-management) framework.
Here's our view, as we wrote it on July 9th:
[I]nvestors should attain broad, diversified exposure to a wide range of asset classes using inexpensive index funds...then supplement that core strategy with an active management discipline that's agile (not bloated), relatively concentrated (not excessively diversified), eclectic (not style-constrained), and absolute-return-minded (not benchmark-hugging).
This is a simple formula, but too often investors get stuck with mutual funds that offer a mediocre mash-up of benchmark-tracking and active management that's too expensive to deliver efficient asset-class exposure and too big and diversified to deliver successful active management. It frustrates us to see investors pay up for active management and receive less than the index-caliber performance they could have enjoyed for a fraction of the cost.
So style drift may be a virtue, but only in the right context. Investors should keep their style-box investments pure and simple with index funds, then let their active manager(s) roam the financial markets as needed. That's a formula for lower total costs, increased investor confidence, and better long-term outcomes.
Source
Joshua Lipton, "Drifting Into Better Returns," Forbes.com, October 5, 2007
