Persistent deviations from a mutual fund's Morningstar Style Box category are sometimes called “style stripping” — when a mid-cap fund starts holding bigger names or a value manager makes a habit of owning growth stocks. But there is a big difference between the meaningful change in style that results from an active manager targeting well-positioned opportunities and a portfolio manager having loose investment standards.
Morningstar-style boxes are often considered the industry standard for analyzing and evaluating a fund's investments. Style boxes categorize funds based on market capitalization (small-cap, mid-cap, large-cap) and investment style (growth, value, or blend). Morningstar also tracks how a fund has invested in those nine segments over the following five years. This can provide a valuable benchmark to see how a fund's current weightings compare to 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 may fall short.
For example, a disciplined active value manager—who looks for securities that offer strong fundamentals, positive business momentum, and are reasonably valued—can and will hold stocks in their portfolios that rank high for value scores. of Morningstar, growth results or both.
To illustrate, take the example of Halliburton.
Before the pandemic hit 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 accelerated. Then, in the first half of 2020, the stock fell to levels not seen in more than 30 years.
At the time, value managers looking at the stock could form the opinion that the company was attractive from a valuation perspective and that consensus expectations for its future growth at the time were unreasonably low for a company with such fundamentals. strong. Given the increasing consolidation in the industry, particularly in the oilfield service space, it was also possible to see a catalyst for change developing.
Halliburton was a stock that could meet the three broad investment criteria above—fundamentals, positive business momentum, and attractive valuation—and was a stock that active managers could buy at a steep discount to its intrinsic value. trusted.
Today, however, Morningstar classifies Halliburton as a growth stock largely because of how dramatically its business momentum has improved compared to shallow benchmarks set during the pandemic. So from the perspective of Morningstar's Style Box categorizations, a value manager holding this company in their portfolio could be penalized.
It's worth considering that Morningstar's value score is the only one that takes into account price, which is often the fastest-changing metric in the stock market. A company's projected earnings—a factor in its growth score—might not change significantly from quarter to quarter, but its price certainly can, affecting the value score it receives. The bottom line is that stocks with strong value characteristics may not hold them for long.
On the other hand, active value managers often need to act quickly to capture attractive opportunities. Style boxes are a useful guide, but far from complete.
Because the best investor is an educated one, transparency is critical when it comes to portfolios and processes. To that end, Morningstar-style boxes remain a valuable tool for understanding more about the types of securities a fund targets, how wide the network is, and how stable it has been over time—critical information in building of the portfolio. But it's also crucial for advisers 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 performance, providing advisors with a reliable framework to navigate market fluctuations and deliver value to their clients.
John Forelli, CFA, is Head of Portfolio Research at Boston Partnersan asset management firm specializing in actively managed value stocks.