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Flexible Versus Style-Pure Managers: The Evidence

Our study finds that managers who hop around the style box perform no better or worse than style purists.

John Rekenthaler, 08/04/2008

In the winter issue of Morningstar Advisor magazine, in an article titled "Fashion Change," we discussed the currently popular belief that so-called flexible U.S. stock fund managers outperform those managers who have more-restrictive investment approaches. This mindset contrasts sharply with the conventional wisdom of a decade ago, when "style-pure" funds were praised for their discipline and their opposites were criticized for being "drifters."

As the article demonstrated, the evidence in favor of flexible managers is scant. Yes, there are several studies that purport to show the superiority of managers who follow flexible investment approaches, but upon closer examination, these studies aren't particularly relevant for advisors who are monitoring funds by how they move among the squares of Morningstar's Style Box. The existing studies either use different definitions of flexibility than style-box consistency, or they are unrealistic, straw-man exercises that do not reflect how Morningstar places funds in the style box.

So, until now it has not been known if flexible managers tend to outgain style-pure managers.

The answer is, they don't. They are not worse overall as a group, nor are they significantly better. They are essentially the same, so say the numbers generated for this publication.

The Study
Here's what we did. For all diversified U.S. equity funds (counting only one share class per fund), we tested the three-year period through March 31, 2008. Each fund tested had 12 quarterly portfolios. If all 12 portfolios registered in the same square of the style box, the fund scored as "low flexibility." If one of the portfolios moved to a second square of the style box and did not move again, the fund registered as "moderate flexibility." Finally, if the fund moved twice or more during the three-year period, the fund was called "high flexibility."

Each of the nine style-box squares was sorted by these three flexibility groupings, so that 27 buckets were created in total. Then, average total returns for each bucket over the trailing three-, five-, and 10-year periods were calculated. So, too, were average standard deviations.

The results are pretty straightforward to interpret and can be seen in the accompanying charts. The figures shown represent the margin of out- or underperformance, per annum, by a given flexibility grouping for a given fund category. For example, over the three-year period, the high-flexibility large-growth funds outgained the large-growth average by 13 basis points per year, the moderate-flexibility funds from the same category trailed by 52 basis points, and the low-flexibility funds led by nine basis points.

To assist in interpreting the results, flexibility groupings that performed at least 50 basis points better than each of the other two groups are marked in green. Conversely, groupings that performed at least 50 basis points worse than their peers are marked in red.

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