While one might think that U.S. equity markets are fluid and fully integrated, in reality there are barriers to the free flow of capital. Some of these barriers are self-imposed by investors. Others are imposed by regulatory and tax authorities or by client guidelines.

Some funds, for example, are prohibited by regulation or internal policy guidelines from buying certain types of stock—nondividend-paying stock, or stock below a given capitalization level. Tax laws, too, may effectively lock investors into positions they would otherwise trade. Such barriers to the free flow of capital foster market segmentation.

Other barriers are self-imposed. Traditionally, for example, managers have focused (whether by design or default) on distinct approaches to stock selection. Value managers have concentrated on buying stocks selling at prices perceived to be low relative to the company's assets or earnings. Growth managers have sought stocks with above-average earnings growth not fully reflected in price. Small-capitalization managers have searched for opportunity in stocks that have been overlooked by most investors. The stocks that constitute the natural selection pools for these managers tend to group into distinct market segments.

Client preferences encourage this balkanization of the market. Some investors, for example, prefer to buy value stocks, while others seek growth stocks; some invest in both, but hire separate managers for each segment. ...

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