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Staying the Course: The Role of Investment Style Consistency in the Performance of Mutual Funds

Keith C. Brown
University of Texas at Austin - Department of Finance
W. Van Harlow
Fidelity Investments
Hanjiang Zhang
University of Texas at Austin - Department of Finance; University of Texas at Austin - Red McCombs School of Business
March 2, 2009

Abstract:

While a mutual fund's investment style influences the returns it generates, little is known about how a manager's execution of the style decision affects portfolio performance. Using both returns- and holdings-based techniques to measure the consistency with which managers approach their investment mandates, we demonstrate that, on average, more style-consistent funds significantly outperform less style-consistent funds on a risk-adjusted basis. This result differs from portfolio turnover and expense ratio effects and is robust with respect to the period used to measure future returns. We also show that fund style consistency and the persistence of risk-adjusted performance over time are distinct influences and demonstrate the potential profitability of trading strategies based on their combined impact. We conclude that deciding to maintain a consistent investment style is an important aspect of the portfolio management process.

Alex’s summary:

Fund managers with a consistent investment style outperform. But duh, managers that are out performing are hardly going to change. Picture this Monday morning breakfast meeting:

Fund Manager #1: Good morning.

Fund Manager #2: Morning. I figured maybe we should change the fund management style. Maybe lighten up on the European industrials, take on a little more pharma and get some exposure to emerging markets.

Fund Manager #1: Why would we do that?

Fund Manager #2: Performance. We have to keep ahead of the market.

Fund Manager #1: How are we doing compared to this time last year?

Fund Manager #2: 18% up.

Fund Manager #1: And the FTSE?

Fund Manager #2: Down 12.

Fund Manager #1: So what’s to change? And anyway, what do you know about that stuff?

If there is one thing the world needs less right now than fund managers it is researchers into fund management.