Protect Yourself From Style Drift In Your Mutual Funds

by Hank Coleman

A good mutual fund is usually one that sticks to its investing style. For example, a mutual fund that promotes itself to potential investors as a value fund should always look for stocks of companies that are trading at less than their true intrinsic worth. All value investors have a contrarian outlook that goes against the herd mentality and looks for stocks that are out of favor with the overall market.  A mutual fund can be accused of style drift when the fund begins to fade away from the strategy it began using to pick stocks to invest in. 

snow-driftsMany times a mutual fund will not even tell its investors that it has changed styles.  That is why investors must be on their toes. It is usually a bad sign for investors when a mutual fund drifts away from its original mandate and strategy.  The drift can indicate that the mutual fund may now be too risky for some investors.  Another negative aspect of style drift is that your mutual fund may not match your investing goals anymore if they begin investing in a different direction.  You may already have a small cap mutual fund in your investment portfolio.  So, if your large cap growth fund starts to drift towards investing in smaller companies, you might not be as diversified as you originally thought.  The diversification of your mutual funds may be in jeopardy thanks to style drift and the potential overlapping of all your investments.

Style drift many not always a bad thing though. Despite its bad reputation, it can also provide evidence that your fund is thriving and growing.  Many mutual funds change course based on the market and where new opportunities are going.  That is okay if investors know about this game plan before it happens.  You do not want to find out that your retirement savings are heading off in a direction you were not aware was even a possibility. 

Style drifts are most common in small cap mutual funds when the small caps market is rising and the investments in these companies rises in market capitalization to the point where the holdings no longer qualify as a small capitalization company. If the mutual fund’s policy is to invest only in smaller companies, then holding this investment would be an example of style drift. This is not necessarily bad. The investment can prove to be very beneficial for the investor, but you should be cognizant of the change in your mutual fund’s investing philosophy and direction.

Another major risk that investors face due to style drift is the inappropriate level of risk that you are potentially facing. Though the risky investments that your mutual fund managers might be dealing with may give a higher rate of return in the long term, it’s not always safe to invest in mutual funds that change their investing philosophy after you have given them your money for safekeeping.

Thus style drift has its benefits as well as its problems and should be watched carefully by investors to avoid any unnecessary investment risk.  No one cares more about your money and your investments than you do.  It is every investors responsibility to watch which companies his or her mutual funds are investing in and to make sure that they are continuing to be true to the investing style you think they should.

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