What Is Style Analysis?
Asset allocation is a strategy for dividing your portfolio among investments in different asset classes - typically a range of stocks, bonds and cash - to help you achieve your financial goals. Each of the individual investments within those classes puts your money to work in different ways, performs differently in different economic climates, and carries a different level of investment risk.
However, choosing the right mix of investments to produce the return you want, at the level of risk you are willing to take, is usually more difficult than determining the allocation model to follow. So how do you know which investments to buy? That's where style analysis comes in.
The part style analysis plays
Each individual investment within an asset class has a distinctive style, or pattern of behavior, which explains much of the return it produces. A mutual fund's style, for example, is determined primarily by its particular asset allocation, or the diversified portfolio of investments that make up the fund. Since no two funds own exactly the same investments in exactly the same proportions, no two produce exactly the same return.
What style analysis can tell you
As an example, a stock fund might describe itself as a domestic stock fund, and you might specifically select the fund to cover that segment of the msrket. Based on that classification, you would expect the fund to produce a return that reflected the performance of US companies during a particular time period.
The question, however, is whether the fund actually performs like a domestic stock fund or, has the fund actually allocated a significant portion of its portfolio to stock in companies doing business overseas? In that case, return-based style analysis would show that a segment of the fund's actual performance was more like that of an international stock fund during the time period in question.
Conclusion
The advantages of style analysis in identifying investments that are suited to your portfolio are its efficiency and impartiality. The only data needed are historical returns, and the method provides an assessment of the investment's behavior independent of its stated objective. Its results therefore let you make an informed decision about the role that investment can play in your portfolio.
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However, choosing the right mix of investments to produce the return you want, at the level of risk you are willing to take, is usually more difficult than determining the allocation model to follow. So how do you know which investments to buy? That's where style analysis comes in.
The part style analysis plays
Each individual investment within an asset class has a distinctive style, or pattern of behavior, which explains much of the return it produces. A mutual fund's style, for example, is determined primarily by its particular asset allocation, or the diversified portfolio of investments that make up the fund. Since no two funds own exactly the same investments in exactly the same proportions, no two produce exactly the same return.
What style analysis can tell you
As an example, a stock fund might describe itself as a domestic stock fund, and you might specifically select the fund to cover that segment of the msrket. Based on that classification, you would expect the fund to produce a return that reflected the performance of US companies during a particular time period.
The question, however, is whether the fund actually performs like a domestic stock fund or, has the fund actually allocated a significant portion of its portfolio to stock in companies doing business overseas? In that case, return-based style analysis would show that a segment of the fund's actual performance was more like that of an international stock fund during the time period in question.
Conclusion
The advantages of style analysis in identifying investments that are suited to your portfolio are its efficiency and impartiality. The only data needed are historical returns, and the method provides an assessment of the investment's behavior independent of its stated objective. Its results therefore let you make an informed decision about the role that investment can play in your portfolio.
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posted by Bob Moser at
3:08 PM
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