Style drift

Style drift is an (gradually increasing) inconsistency between the stated strategy that a portfolio or fund should follow (e.g., as specified by its mandate) and the actual investments made.

Why style drift occurs

The main reasons style drift occurs is that fund managers are usually strongly motivated to out-perform in the short term. This provides a temptation to switch to a strategy or asset class that is expected to out-perform in the short term.

An example of this would be the manager of a value fund buying growth shares. This is a common temptation because growth share provide a better chance of short term out-performance through active management (even though their long term performance tends to be worse in the long run).

Drift also often occurs through re-allocation of assets — for example, a manager of an equity fund who has a pessimistic outlook may hold cash or bonds.

Identifying style drift

The simplest way to check for style drift is to look at what holdings a fund has. A change company size or the sector weighting may be an indicator of style drift. This is needs continuing monitoring: a fund that has stayed consistently with its stated style so far, may well change before it next reports its holdings.

If the benchmark is a style index, then a decrease in the correlation of a fund's performance with its index or an increase in its tracking error. This does highlight an advantage of style indices as benchmarks: an increased risk to managers from indulging in style drift, as it increases the risk of under-performance.

A more sophisticated approach uses a numerical measure of style drift along with similar numbers to classify a portfolio's style and style history.

Immunity of index funds

Index trackers and mechanical strategies are immune to style drift. This does assume that if a style index is tracked, that the index is itself well constructed enough to be free of style drift. Indices are invariably very carefully constructed and are more transparent than funds so this should not be a problem.