How to Tell if Your Fund Is Straying Off Course
Nowadays, cars often alert the driver when they drift into another lane—and maybe even self-correct. Unfortunately, your mutual funds don't do the same.
Examples of style drift, in which a fund meaningfully departs from its stated objectives, are everywhere: value funds investing in high-growth technology stocks, small-cap funds with significant mid- and large-cap exposures, developed-market funds straying into emerging-market territory—the list goes on.
"It's not surprising for a fund to stray from its mandate for a quarter or two as its managers pursue tactical opportunities or attempt to reduce risk," says Michael Iachini, CFA®, CFP®, managing director and head of manager research at the Schwab Center for Financial Research. "When such changes constitute a conscious shift in strategy, on the other hand, it can be cause for concern."
The U.S. Securities and Exchange Commission's Names Rule, which mandates that a fund invest at least 80% of its assets in investments its name suggests, is supposed to act as a safeguard against significant drift. Even so, fund managers have some degree of flexibility, and many funds choose imprecise names that allow them to invest more broadly. "At its most extreme, style drift can leave you over- or underexposed to key elements of your target asset allocation and potentially expose you to undue risk," Michael says.
Fortunately, there are steps you can follow to help determine whether your fund is changing lanes.
Log in to Schwab's Research Tools, enter the fund's name or ticker symbol in the search field, and:
- Check its exposure: In the Portfolio window, click "+ Show More" to view the percentage breakdown of the fund's holdings by asset class, market cap, region, or sector. Large allocations that seem out of step with a fund's strategy may indicate style drift.
- Square it up: Within the Ratings window, the Morningstar Style Box shows how much the fund invests in one of three investment styles (value/growth/blend) and by market cap (small/mid/large). Does this assessment align with your expectations for the fund?
- Investigate outperformance: A fund whose returns outpace its benchmark may be taking on excess risk. To check, go to the Risk & Tax window and click "+ Show More" to examine its beta and standard deviation—two backward-looking indicators of risk-taking. If those metrics rise over time (something you'll have to track yourself), the fund has become riskier and may no longer align with your goals.
- Call in the pros: Search for funds on Schwab's Mutual Fund OneSource Select List®, which actively monitors for style drift. Michael and his team contact fund managers when they see significant changes, going so far as to remove funds from the list when they're misaligned with their promised objectives.
"A bit of ebb and flow in style is natural," Michael says. "It's when those shifts start to erode consistency or steer the fund away from what you signed up for that you might want to reconsider its place in your portfolio."
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