One of the downsides of using actively managed fund is what's called style drift. It's a widespread phenomenon, and, unless you're looking out for it, the danger is it can give you a nasty surprise.
Many of us learned a new skill during the Covid pandemic, and for me it was cooking from scratch. I love the simple pleasure of choosing fresh natural ingredients and then turning them into a nutritious meal. I'm not an expert cook, believe me, but I'll never go back to buying processed food with long lists of obscure ingredients.
There are close similarities between food and investments. Building a portfolio is rather like shopping for groceries. You can either fill your cart with wholefoods like organic meat, wild-caught fish, fresh fruit and vegetables, nuts, grains and legumes. Or you can buy pre-packaged food you can just put in the microwave — yes, far more convenient, but not very good for your long-term health.
Actively managed mutual funds can be rather like convenience foods. They're often heavily advertised and made to look as though they're much better for us than they are. Worse still, you may get a nasty surprise when you discover what they actually contain.
In fact, the labeling of investment products can be even more misleading than food labels. Take equity funds, for example. Stocks come in many varieties. There are large-cap, mid-cap, small-cap and micro-cap stocks, growth stocks, value stocks, momentum stocks, low-volatility stocks, high-dividend-yielding stocks — the list goes on.
The problem, as Mark Hebner explains in Step 6 of his book Index Funds: The 12-Step Recovery Program for Active Investors, is that no industry-wide standards exist for defining these terms.
"To make matters even more difficult," Hebner writes, "carefully crafted fund prospectuses give active fund managers significant leeway to deviate from their fund's stated investment style. As a result, companies with divergent risk and return characteristics are often lumped together into the same style."
The phenomenon Hebner is referring to is called style drift.
© The Evidence-Based Investor MMXXIV. All rights reserved. Unauthorised use and/ or duplication of this material without express and written permission is strictly prohibited.