A Matter of Style: The Causes and Consequences of Style Drift in Institutional Portfolios
Russ Wermers, University of Maryland

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 holdings-based 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, book-to-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 stock picking 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. Overall, our findings suggest that controlling the style drift of a fund manager does not necessarily result in higher performance for investors.

Style drift and its causes greatly concerns investment sponsors who generally prefer to hold risks that they understand and can predict. Using measures based on portfolio holdings, this research project examines components of style drift and shows that much drift results from the selection decisions of active manager, many of whom produce better performance as a result of their decisions. Close management of style drift therefore may not always be in the best interests of investment sponsors.