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17 February 2017

What is style risk?

By Ryan Lightfoot-Brown, Research Analyst

When people hear the word style, they are more likely to think Carnaby Street than Canary Wharf, but in the investment world, a fund's investment style is a very important factor that can easily leave an investor lagging, even though they may have picked managers that are otherwise very good.

Investment style refers to the type of stocks a fund manager seeks. Typically this is determined by the company size (small cap to large cap) or by stock type, either growth or value. This style will reflect the sort of companies in which they invest, and therefore how the fund will perform in different economic conditions.

What style of funds do you own?

The first thing you can do to mitigate this risk is to understand what style of funds you own, although not all funds have an obvious style bias. FundCalibre research notes for Elite Funds will usually explain the type of stocks in which a fund invests and if it has a value bias.

Why does it matter?

When one of these styles is in favour, the other is usually out-of-favour and these trends can stay in place for long periods. As a trend persists, the same style of funds are likely to be the best performers, which then typically drives investment choices. Increasing style risk is easy to do and often goes unnoticed.

This can make a portfolio very exposed to a sudden change in style. Having a large proportion of funds investing in the same type of companies will create a very lopsided portfolio. Investments are then likely to perform very similarly and, should your style be out of favour, go down together.

This is why constantly switching between funds and following what did well recently is rarely the right approach. It is virtually unheard of that a fund manager is able to beat the market every year. Even the very best managers go through periods of underperformance and the main reason for this is when their style goes out of favour.

The best way to mitigate this risk is to hold a variety of different funds and styles to create a balanced portfolio, don't just look at which funds have performed well recently. If you have a strong view, you can tilt your portfolio towards it but know that there is support in case this view doesn't play out.

Funds should be selected based on their long-term performance, not just whether they are top of the charts over one year. A diversified portfolio of different styles and assets with a long-term view will give you the best chance.

Where to next?

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius' views are his own and do not constitute financial advice.

©2017 FundCalibre Ltd. All Rights Reserved. The information, data, analyses, and opinions contained herein (1) include the proprietary information of FundCalibre, (2) may not be copied or redistributed without prior permission, (3) do not constitute investment advice offered by FundCalibre, (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be correct, complete, or accurate. FundCalibre, shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses, or opinions or their use.