“Oh give me land, lots of land under starry skies above, don’t fence me in,” by Cole Porter and Robert Fletcher, isn’t just a cowboy song–when it comes to managing an investment portfolio, fences, or perhaps style boxes, may not make the best neighbors. At the IA Wealth Advisor Summit, Craig Callahan, founder and president of ICON Advisors, Inc. in Greenwood Village, Colorado, made a compelling case for releasing portfolio managers from the constraints of style boxes. In fact, he said that hiring a manager to manage to a style box could mean that investors do not get that manager’s best picks, a thesis Callahan first discussed in the September issue of IA, (see original story )
A panel including Ranji Nagaswami, vice chairman and CIO at AllianceBernstein, in New York; William Fries, managing director and portfolio manager at Thornburg Investment Management in Santa Fe, New Mexico; and moderator Philip Edwards, managing director of Standard & Poor’s Investor Services in New York, discussed whether style boxes are necessary.
Callahan says that part of the issue is “style” versus “characteristics” of a fund. He defines “style” as the “method of investing” and characteristics as the grid that typically makes up style boxes: “value, blend or growth; and small-, mid- and large-capitalization.” Style constraints “cost about 300 basis points in performance” annually, he says, citing a Wermers, University of Maryland 2002 working paper that attributes 3.23% alpha to style drifters in the top 10 percentile. When you think about it, if a manager picks a stock where the market cap increases from small cap through mid cap to large cap, don’t investors want to be there for the ride? If she’s got to get rid of it when it goes out of her part of the grid, what happens to the rest of its run? “Give a manager the ability to determine what box to go in, to find the sweet spot of the grid,” argues Callahan, adding that managers with a “rigid style and system can be pulled to the sweet spot on the grid,” but they need the freedom to be able to go there.