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Step 6: Style Drifters

Problems Style Drift Alters Risk Exposure There are different risk characteristics among the many categories of investment styles. An index or asset class is designed to carry a particular risk exposure, a key identifying factor for any fund. Market capitalization styles include large cap, mid cap, small cap, and micro cap stocks. A growth style commonly pertains to stocks that have experienced rapid growth in earnings, sales or return on equity, as well as low book-to-market ratios (BtMs). A value style, on the other hand, refers to stocks that have carried low price to earnings ratios, high BtMs, and are often labeled as “distressed.” Beyond these broad descriptions, funds are sorted into categories such as domestic, international, emerging markets, select technology, health care, energy, and others. No industry-wide standards exist for defining these terms, making it hard for proper benchmarks to define what constitutes value, growth, large cap, small cap, international, or emerging market stocks. To make matters even more difficult, 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.

Style Picking When active fund managers assume their fund’s investing style will underperform, they often abandon their stated

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