A Real Head-Scratcher

Style Provocation

I recently read the article, “Thinking Outside the Box” in the September 2005 issue, on style-constrained investing.

I’m not disputing the authors’ findings, since I’ve neither done the research nor do I believe that style boxes are the end-all-and-be-all. But, I did find it peculiar that they comment that there is no empirical research for the basis of style investing.

Maybe there’s no single peer-reviewed work that “gave” us style boxes, but didn’t Fama and French start using cap and book-to-market in their capital asset pricing models? Meanwhile, Sharpe’s Nobel Prize-winning work was key to bringing “effective asset allocation” to the Frank Russell Company for pension plans; and, later such tools as Barra’s models at Wilshire focused on size and growth/value factors in helping examine portfolio and security risk. At first, these were after-the-fact categorizations of managers’ performance attributed to growth/value and large/small. More interesting was how managers started designing portfolios around these boxes and their marketing teams sold them that way–something of a chicken-and-egg problem perhaps.

Again, I’m not disputing this one study’s findings, since most of the best investors think that style is “joined at the hip.” I mean who doesn’t want to buy low, sell high? And, now that we have them, style boxes are convenient to help clients learn to diversify and conceptualize different market risks. Moreover, benchmarking in some manner helps separate skilled managers from lucky ones rather than relying on their marketing a well-articulated philosophy and process. For better or for worse, style boxes–along with alpha, tracking error and all the rest–are here to stay. Sure, some tools are better than others and there are no answers in the back of the book.

But, to comment that there’s “no inaugural article or empirical basis for the approach” is a little provoking, isn’t it?

Paul G. Escobar

Sapers & Wallack Advisors

Cambridge, Massachusetts