Persistent deviations from a mutual fund’s Morningstar Style Box category are sometimes called “style drift”—when a mid-cap fund begins holding more large cap names or a value manager makes a habit of owning growth stocks. But there’s a big difference between meaningful style drift that results from an active manager targeting well-positioned opportunities and a portfolio manager having loose investment standards.
Morningstar’s style boxes are often considered the industry standard for analyzing and assessing a fund’s investments. The style boxes categorize funds based on market capitalization (small-, mid-, large cap) and investment style (growth, value or blend). Morningstar also tracks how a fund has invested across those nine segments over the trailing five years. This can offer a valuable point of comparison in seeing how a fund’s current weightings stack up with its typical allocations. Tracking a fund’s allocations over time provides advisors with valuable and objective insights, but understanding Morningstar’s calculation methodology can also help inform where these rankings can fall short.
For instance, a disciplined active value manager—who seeks out securities that offer strong fundamentals, positive business momentum and are reasonably valued—can and will hold stocks in their portfolios that rank highly for Morningstar’s value scores, growth scores or even both.
To illustrate, take the example of Halliburton.
Before the pandemic struck in 2020, the energy industry was still working through the effects of a fairly dramatic collapse in energy prices coupled with an oversupplied market, particularly in North America, where investment in fracking had been accelerating. Then, in the first half of 2020, the stock plummeted to levels not seen in more than 30 years.
At that time, value managers viewing the stock could form the opinion that the company was attractive from a valuation perspective and that the consensus expectations for its future growth at that time were unreasonably bearish for a company with such solid fundamentals. Given the increasing consolidation in the industry, especially in the oilfield service space, it was also possible to view a catalyst for change emerging.
Halliburton was a stock that could meet all three of the broad investment criteria above—fundamentals, positive business momentum, and attractive valuation—and was one that active managers could purchase at a steep discount to its believed intrinsic value.
Yet today, Morningstar classifies Halliburton as a growth stock mainly because of how dramatically its business momentum has improved relative to shallow points of comparison set during the pandemic. So, from the perspective of Morningstar’s Style Box categorizations, a value manager maintaining this company in their portfolio could be penalized.
Worthy of consideration is that Morningstar’s value score is the only one considering price, which is often the most rapidly changing metric in the stock market. A company’s projected earnings—a factor in its growth score—may not meaningfully change from one quarter to the next, but its price certainly can, affecting the value score it receives. The bottom line is that stocks with strong value characteristics may not retain them for long.
On the other hand, active value managers often need to act quickly to capture attractive opportunities. Style boxes are a helpful guide but far from definitive.
Because the best investor is an educated one, transparency is critical when it comes to portfolios and processes. To that end, Morningstar’s style boxes remain a valuable tool for understanding more about the types of securities a fund targets, how wide a net it casts, and how consistent it’s been over time—critical information in portfolio building. But it’s also essential for advisors to remember that in active management, the delineation between styles is often fluid, and the variables that dictate an individual security’s classification can change quickly and dramatically—especially in volatile markets.
In any market environment, advisors must recognize the enduring value of a disciplined investment approach. Prioritizing securities with compelling valuations, solid business fundamentals, and favorable business momentum is a time-tested strategy. Such characteristics often underpin long-term outperformance, providing advisors with a reliable framework for navigating market fluctuations and delivering value to their clients.
John Forelli, CFA, is Head of Portfolio Research at Boston Partners, an asset management firm specializing in actively managed value equities.