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Market Strategist

Don’t Be Boxed Into Style Boxes


As investors adopted modern portfolio theory, which began in earnest in the 1980’s, they also embraced the idea of style investing. The most common form of style investing segments the market by size of company and value vs. growth. The idea was advanced by Morningstar, with their now well-known style boxes, as it sought to give individual investors a meaningful framework for understanding underlying exposure. It also allowed investors (1) to ascertain if style managers were sticking to their style and (2) to compare the performance of those managers against similarly benchmarked peers.

Using the language of style investing became commonplace between an adviser and the client as the trend reached the general investor community. Today, advisers compare the pros and cons of various investments by discussing large-cap growth or small-cap value with their clients. Although this language has added context to how we understand investing data, it didn’t necessarily result in better returns.

The mutual fund industry relied on the style box nomenclature to differentiate and market their funds. And advisers have leveraged the marketing material. It’s now standard practice for advisers to highlight the style tilts within their portfolios and to focus on refining or replacing managers within the distinct boxes.

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Related: Allocating by the Phases of Life

Style box investing and focusing on asset allocation naturally lends itself to a transactional-type discussion. And it’s hampering the transition occurring today in the financial-advisor industry, away from the transactional elements of advice to fee-based advice.

Typically lost when we talk style-box investing is that the vast majority of investment returns can still be understood in a framework that considers merely timing (i.e., when to be in the market and when to be out) and allocation (i.e., between equities and fixed income). The language of style investing might help your clients mentally organize their investments, but a volatile market reveals the boundaries of that conversation’s utility. It’s like discussing how to arrange the deck chairs when your clients think the ship might be sinking.

Clients lose about a quarter of the market’s return potential because they react to short-term volatility, feeling out of control as markets experience losses. To give clients true value and optimal returns, advisers need to help them stop themselves from doing the wrong thing at the wrong time. The conversation today needs to move away from which boxes to be in to the client’s own long-term objectives and how, despite volatility and short-term losses in the markets, the client is still on plan.

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