Tracking Funds as They Migrate Across the Style Box

The Morningstar Style Box has a lot of stories to tell.

We can shade in the section of the style box where a fund's current portfolio has most of its holdings. We can also draw an amoebalike Morningstar Ownership Zone that encompasses most of the portfolio and typically sprawls across two or three of the sections. This nicely illustrates the true stretch of a fund and the fact that very few funds stick to just one of the nine boxes. Or we can plot a centroid for a fund's portfolio and then track where it moves (snail-trail style) across the style box. This tells you the story of where a fund has moved over time.

It's this centroid movement that we'll look at here. Funds with big centroid movements often have undergone a strategy shift. Other times, it's simply a manager moving in the direction of what he or she thinks are better opportunities. Finally, it can even be that the market itself moves and the fund hasn't changed holdings. Remember, these are all relative measures, so if a fund favors health-care stocks and health-care stocks rally to higher valuations, then the fund would likely move farther to the right of the style box even without making any trades.

I'll take a look at the funds whose centroids have moved the greatest distance across the style box. It's useful information because these changes might lead your overall portfolio to tilt one way or the other. In addition, it's helpful to understand what your portfolio managers are doing. First, a quick rundown on how we calculate the style box.

Style Box Basics
The style box grid aims to capture market capitalization on the vertical y-axis and value/growth characteristics on the horizontal x-axis.

To plot market cap, we calculate a mean-weighted market capitalization for each portfolio. The lines for small-, mid-, and large-cap funds float with the market as it goes up and down. We put the top 70% of a market's value in large caps, the next 20% in mid-caps, and the final 10% in small caps.

For value and growth, we look at five valuation characteristics and five growth characteristics. The characteristics were chosen based on market behavior and fund manager investment criteria. Each is converted into a relative score so that it can be combined into one x-score for each portfolio. Here's how it shakes out.

To build a value score, we give a 50% weighting to price/projected earnings. We give 12.5% weightings to these historical-based measures: price/book, price/sales, price/cash flow, and dividend yield.

To build a growth score, we give a 50% weighting to long-term projected earnings growth. We give 12.5% weightings to these historical-based measures: book value growth rate, sales growth rate, cash-flow growth rate, and historical earnings growth rate.

The five value and five growth characteristics for each individual stock are compared with those of other stocks within the same scoring group. If either growth or value is dominant, the stock is classified accordingly. If the scores for value and growth are similar in strength, the stock is classified as "core." Roughly one third of stocks are assigned to value, one third to core, and one third to growth.

The Meaning of the Style Box
For the record, the style box is not a coloring book. We don't sound alarms if a manager goes over the line. Rather, we view the style box as a useful way to understand fund strategies and to put together a portfolio. We only sound alarms if a manager has changed strategies. Strategies don't necessarily fit into one of the nine boxes, so a move from one box to another does not mean there is a change in strategy.

Yet it's clear that the style box is capturing something real. In the 1990s, growth did far better than value, and in the aughts, value did far better than growth. Likewise, small caps dominated in the aughts but not in the 1990s. So, an investor who diversified around the style box would have avoided the extremes of the market. In addition, it helps investors avoid confusing a mediocre fund in a hot spot of the market from one that is truly adding value relative to peers.

Who's Moving?
I looked at centroid movement from the end of 2006 to the end of 2009 portfolios. We measured the distance between the two centroids to see which have moved the most. On this PDF we have plotted the 12 that moved the greatest distance. The red is where they finished 2009 and the black is where they began 2006.

 Weitz Partners Value (WPVLX)and  Weitz Hickory 
Wally Weitz has taken these two funds toward the southwest (small-value) corner of the style box. Both dropped significantly in market cap and valuations. The reasons encompass all three of the reasons I spelled out earlier for style movement. First, Weitz has designated Partners Value an all-cap fund, while  Weitz Value (WVALX) remains a large-cap fund. That's apparent from the big shift down by Partners Value, while Value only moved down a hair.

The move farther to value was partly the market's doing. Both funds enjoyed strong performances in 2006, which nudged valuations higher, but they had a rough 2007 and 2008 as some financials and some deep-value holdings got whacked. However, many of those names continued to produce earnings and strong cash flow through the recession so that even after a nice rebound in 2009, they were still farther to the value side than they had been. Finally, Weitz has been finding bargains among beat-up mid-cap companies such as  AutoZone (AZO) and insurance broker  Brown & Brown (BRO).

 Fairholme (FAIRX)
You can see Bruce Berkowitz found a different type of stock appealing at the end of 2009 than he did in 2006. He has shifted from natural resources into depressed financials stocks. In fact, he's continued buying up beaten-up financials in 2010. He also was adding some depressed health-care names and cut back on his  Berkshire Hathaway (BRK.A) stake over that time. This is a great example of how movement in the style box doesn't mean a strategy shift. Berkowitz just found undervalued businesses in a different sector with different valuations.

 Fidelity Dividend Growth (FDGFX)
In September 2008, Larry Rakers took this portfolio over after Charles Mangum had been removed because of poor performance. Rakers quickly jettisoned Mangum's blue-chip portfolio in favor of an all-cap, all-valuation strategy. Thus, the fund moved down in market cap significantly to a $10.5 billion average market cap, which is just over the line for large caps. It's a strategy that worked well for Rakers at  Fidelity Balanced (FBALX). If this had been your sole source for mega-cap exposure, you might want to consider adding  Jensen Fund (JENSX) or an S&P 500 fund to keep your portfolio in line.

 Fidelity Small Cap Stock (FSLCX)
Andy Sassine has taken this fund in a northwesterly direction. Since taking over in 2008, he has taken the fund's centroid just over the line into mid-caps while moving from growth almost to the value/blend borderline. He chucked micro-cap stocks in favor of a contrarian bet on banks such as  Citibank (C), which has paid off nicely for the fund. Given those results, he probably won't hear a lot of complaints about the strategy change. Interestingly, he has a big bet on U.S. airlines, which have held up better than the European airlines in the wake of the Icelandic volcano.

 Janus Orion (JORNX)
John Eisinger has taken this fund from the extreme edge of growth to more-modest growth, though market cap is little changed. While a few high p/e, high-growth names such as  Apple (AAPL) and  Celgene  remain, Eisinger has also bought a number of value or core plays. He's got cyclical names such as  Illinois Tool Works (ITW) and Ivanhoe Mines  alongside modest but steady growers such as  Anheuser-Busch InBev (BUD). Yet performance certainly hasn't been tame. A concentrated portfolio means that the fund has been top or bottom quartile in Eisinger's two full years at the helm.

 Chase Growth (CHASX)
While Janus Orion was moving toward the value side, Chase Growth dialed up the growth, and it has the poor performance to show for it. The fund moved into names such as  Google (GOOG) and Apple, but, unfortunately, it was cyclical companies and financials that had the highest returns in 2009. With a turnover rate of 180%, though, this fund doesn't stay in one place for long.

 Fidelity New Millennium (FMILX)
Since taking over for the legendary Neal Miller in 2006, John Roth has shifted the fund northwest from the extreme mid-growth slot to large-blend with a slight growth tilt. Roth mixes steady growers with fallen angels, whereas Miller aimed to be early on giant trends. Roth's tenure has been a revelation. He had managed some sector funds, but this was his first diversified fund, and he's produced gangbuster results. It's disappointing that the fund now plies a strategy not unlike many other Fidelity funds, but I'm encouraged that it appears to be in good hands.

 Meridian Growth (MERDX)
Rick Aster isn't doing anything differently. It's mostly that names such as  Adobe Systems (ADBE) and  Solera  have rallied sharply, and he has held on as valuations rose. So, it's a little funny to find a growth-at-a-reasonable-price fund like this moving toward the far end of growth.

The fund's performance isn't easily explained by how well growth is doing as much as by its individual holdings. For example, it held up beautifully in the previous two bear markets and did well in the speculative rebound of 2003. Yet it suffered bottom-quartile years in 2005 and 2007, so it's not bulletproof.

 Fidelity Growth Discovery (FDSVX)
Jason Weiner ratcheted up this fund's growth orientation after he arrived in 2007, but it was a deep-value bet that has really hurt the fund. He scooped up financials in 2008 while they were crashing and then doubled his error by quickly selling in 2009, so he didn't get much pop from their rebound. The result was two years of terrible performance at a time when most funds outperformed in one or the other. Today, he still owns bank survivors  J.P. Morgan Chase (JPM) and  Wells Fargo (WFC), but he's got even more in network technology and other high P/E growth names.

 Royce Special Equity (RYSEX)
Royce Special Equity has moved more to the growth side for the best of reasons. Charlie Dreifus bought cheap stocks with strong balance sheets, and the market came to appreciate them and drove up their prices and multiples. Dreifus only has a 10% turnover rate, so the portfolio hasn't actually changed much over those three years, but the market has.

This article originally appeared in Morningstar FundInvestor. 

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