The widely accepted style grid of market capitalization and price-to-earnings ratios was largely arbitrary in design, lacking substantial research or academic foundation. An alternative framework based on how managers actually manage their portfolios and organizing around those investment strategies provides a superior alternative for organizing and comparing funds.
Examining investment strategy can be useful when evaluating mutual funds, but what information is contained in fund holdings? Do they reveal stock-picking skill?
Funds that consistently pursue a narrowly defined investment strategy while taking high-conviction positions outperform.
Rather surprisingly, the equity strategy framework can provide an estimate of current expected stock market returns. This is accomplished by measuring the recent investor response to each strategy, which, it turns out, captures the deep behavioral currents driving market returns. The resulting information is useful when managing equity market exposure.
High return dispersion and volatility are a stock picker’s nirvana.
Classifying funds based on their investing strategies instead of via the traditional style grid presents a new way to look at diversification.