Common Sense on Mutual Funds: Fully Updated 10th Anniversary Edition

Chapter 6. On Equity Styles: Tick-Tack-Toe

In recent years, "style purity" has become the catchphrase of portfolio managers, investment advisers, and mutual fund investors. Mutual funds—sometimes enthusiastically, sometimes reluctantly—are defining their investment strategies and investment policies more clearly. The managers of individual stock funds today feel pressured to keep the portfolios they manage fully invested at all times, and to confine themselves to a given portfolio style that defines the fund's strategy—growth stocks versus value stocks, for example, or large-cap stocks versus small-cap stocks.

A powerful argument can be made that the choice of equity fund styles—like the choice of fund portfolio managers—is just one more example of industry witchcraft. Just as absolutely no brute evidence exists that past fund returns are the precursors of future returns, so there is little, if any, evidence that there are superior investment styles that prevail over time. In both cases, above-average returns and below-average returns revert to normal levels; individual fund returns revert to appropriate market index norms, and equity styles revert to total stock market norms. (In both cases, I am speaking of fund returns before the deduction of costs.)

Why bother with styles at all? This is not a trivial question. There are powerful reasons for owning the entire stock market, or even large-capitalization blended (growth and value) funds, the particular fund style that most strongly ...