Style Drift Among Value and Growth Funds

Abstract

In the United States, retail investors rely heavily on the mutual fund industry to meet long-term objectives such as preparing for retirement. One segment of the mutual fund industry identifies as value stock funds, while another identifies as growth stock funds. Anecdotal evidence suggests that mutual funds in both categories deviate from their stated style for some of their purchases. We identify what proportion of each types’ funds are invested in crossover stocks that do not fit the funds’ stated investment styles and whether this deviation earns abnormal positive returns. We find that mutual fund managers frequently hold stocks outside their identified style; this effect is larger for value fund managers holding growth stocks. We find that, on average, growth fund managers earn higher returns than their index on these “crossover” stock holdings. We conduct a simple attribution analysis and provide weak evidence that managers of large-cap growth funds can time their investment in value stocks, and strong evidence that both large and small-cap growth fund managers can successfully select underpriced value stocks. The same is not true of value fund managers.

TOPICS: Exchange-traded funds and applications, mutual fund performance, manager selection

Key Findings

• • Managers of value funds, particularly small-cap value funds, frequently and consistently deviate from their stated fund objective.

• • Deviating from fund style does not generate excess returns for value fund managers by either timing or selection.

• • Growth fund managers generate excess returns by investing in value stocks, particularly from selecting underpriced Value stocks, though they deviate from style less often.