Style box for the investor is a visual representation of investment characteristics for stocks, fixed income and mutual funds offered as a comparative tool to investors around the world for helping them determine asset allocations based on their risk preference.
Should an idea nearing 30 years of history need revisiting? Is the style box a good visual representation? Why should we bother with a mere visual? Maybe that’s why no one asked this question, is there something wrong with the style box? Is it still a good representation? Is questioning this representation essential for our broad comprehension of risk? Can we afford to be complacent about visual representations which determine our investment choices?
Industry standards are important for the investing community. When a standardized metric talks about risk-return structure, it’s representation concerns me. Is it doing a good job for me as an investor? Is it dependable?
We know all the good about the style box. The mapping value it brought to the industry. Let’s rethink about the map. Societal inability to look at investing style grid from another angle is a limitation. Because we are designed to accept status quo and not question it. It’s harder to force the society to think. What if the style box was wrong? What if markets and risk were summarized by a better representation? This would mean that millions of investors are looking at the wrong map and the idea of informed comparison might just be a flawed comparison.
A different visual map for a different asset class. Fixed income is different so it has a different visual. And so are stocks and mutual funds. Is there a visual map that could generalize for all asset classes in a single map? Are risk and return not common across asset classes?
Though the style visuals change for asset classes (there are none for commodities or currencies) but few of the factors overlap. The style box looks at value and growth as a commonality between fixed Income and stocks but still represents them separately.
After all the debate around CAPM, with behavioral finance expert calling it CRAP (Completely Redundant Asset Pricing Model) while academic literature clearly saying that CAPM is not completely redundant, the style box assumption that small size adds riskiness to the portfolio is more of a visual generalization of a tendency.
There are size factor and value factor. The industry is already toying with more factors. The academic literature talks about 15 factors. What about sentiment as a factor? What about volatility? The current style visual has a limitation to scaling up for more factors.
The style box comparison assumes geographical area. With the investing space increasing and investors looking at macro markets, how relevant is a constraint of a geographical area? Why can’t we have global value, global growth, and other factors in one representation? Is it a tough exercise to label value for a global portfolio? What earning constraints should we have for a global portfolio to be classified as value or growth? Does this exercise become a big data-crunching problem which is beyond the scope of the 30-year-old visual or that was not the initial mandate of the visual?
The changing times demand better solutions, visual or nonvisual. The move from active MF’s to ETFs is already a big change, which suggests that a new style box should be able to classify ETFs. How should we classify ETF? What about tactical funds? How should we classify everything in one simple visual, a new framework?
The bigger limitation for style box and for the industry is to take a step back and differentiate factors from behavior. Is momentum a factor or a behavior?
Investing Style is assumed because of what Graham and Dodd started discussing ‘Value’ in the 1920s. Then came Basu, Banz, Fama, Stattman, Klein, and Bawa. The history of literature from 1920’s open up more than a gap in our understanding of factors. There is duplication, proxy, redundancy, limitation in an understanding of the factors. What if Investing style definition evolving sentimentally over the last 100 years was more of an investing style bias?
Does the style box scoring need a revamp? Do we need a new score to reclassify risk and (with) style? Feeding the same information back to the industry which reflects it back in a loop, is not the hallmark of a relevant industry standard. The industry needs a revamped representation.
Unlike the new, the old visual is about value and size. The new should consider value and size as few of the many factors. While momentum (positive trend), reversion (change in trend) should be the common behavior (not be confused with psychological behavior) for every factor in nature. Everything in nature (including stock market prices) grows and decay. Growing trends can continue to grow or reverse and start to decay and vice versa. Winners can continue to win (momentum) or start to underperform, lose (reversion). The markets need one visual for every traded asset, which addresses every factor, including sentiment.
The Old vs. New Style