How Russell Puts the Brakes on Style Drift

Provided by Russell Investment Group

August 29, 2001

In challenging times, some money managers are tempted to widen their horizons a bit too far. Russell's continuous style balancing helps keep funds within preset parameters and minimize volatility.

It's one thing to preach diversification. But it's another to create a systematic approach to assuring that funds will stay balanced to reduce volatility—even when some fund managers may wander a bit from their usual investment strategies.

"Style drift"—for example, a small-cap fund buying mid- and large-cap stocks or a value fund buying growth stocks—can create greater risk. An investor may purchase several funds to achieve diversification within an asset class. But if one or more funds morph into something else—often without an investor's knowledge—diversification is reduced.

Value managers in particular face serious challenges, according to Dennis Trittin, Large Cap Portfolio Manager at Russell. "Defensive stocks like utilities, financials, foods and beverages did well last year, so valuations are no longer as attractive. This year, depressed industrials and retailers have rallied sharply. It's harder to find compelling sectors, so value managers are spreading their selections."

Many growth managers are also branching out from a former technology focus. But should they resume concentrating assets into a single sector, their funds will assume more risk.

As Holiday Inn used to say in its TV commercials, "The best surprise is no surprise." That's why Russell benchmarks its funds, setting standards for balance. Style indexes based on the broad-market Russell 3000® Index place stocks in three basic style categories:

• Pure Growth—high-growth companies such as Pfizer. All of the market cap of these securities is assigned to the Growth index.

• Pure Value—such as electric utilities with slow growth and low valuations. All of the market cap of these securities is assigned to the Value index.

• Partial Growth and Value—for example, Disney. This media company represents average growth and valuations. So Russell allocates a portion of Disney's market value to both the Growth and Value indexes.

Further, Russell reconstitutes its indexes yearly.

Do stocks ever move from one index category to another? They do. "Last year, many traditional growth stocks had lower forecasted growth rates and lower valuations," Trittin said. "Their classification went to partial growth and value from pure growth. The process is gradual, however. It would be rare for a stock to go from pure growth to pure value in a year.

Russell also carefully tracks fund managers. "We know managers' style biases over their history," Trittin points out, "and how they define growth or value." Some managers stay fairly strictly within their styles. Others wander away now and then based upon changing market opportunities. The legendary Peter Lynch was such an investor. That's fine as long as these managers come back again and each Russell fund meets its diversification requirements. Funds, like investors, can get out of sync when their money managers begin shifting styles. What's critical is a knowledgeable, flexible approach that controls aggregate portfolio risk.

What happens when some managers become more aggressive or defensive? "We look at how and why they change their positions," Trittin said. "But we rarely have to replace managers due to style drift because we know them well before we ever hire them. When we combine managers into one overall fund, we have our bases totally covered across the style spectrum."

Keeping pace with style drift can challenge the most accomplished individual investor. But with Russell providing research and manager selection, investors may appreciate time savings as much as solid long-term returns.