DETROIT — The three-year assault on mutual fund style boxes as an evaluation and asset allocation tool has moved to the beta-testing level by a firm that seeks to turn the traditional grid system inside out.
DETROIT — The three-year assault on mutual fund style boxes as an evaluation and asset allocation tool has moved to the beta-testing level by a firm that seeks to turn the traditional grid system inside out.
“There is no empirical basis for the idea of constraining money managers to boxes,” said Craig Callahan, co-founder and principal of AthenaInvest Inc. in Denver.
“The style boxes were pounced on originally as a marketing gimmick, but our research shows the funds inside any given box are as dissimilar as the funds outside of a box,” added Mr. Callahan, who is also founder and president of ICON Advisers Inc. in Greenwood Village, Colo.
AthenaInvest, which started beta-testing its system with more than 140 financial intermediaries two weeks ago, evaluates and categorizes mutual fund managers based on publicly available data related to each fund’s stated investment objectives.
The objectives, which are identified in the form of multiple management style elements, allow AthenaInvest to break down the entire mutual fund universe into 10 strategies.
The company plans to go live in late July with its strategies-based platform, which also will include a whole new set of equity market benchmarks.
The primary distinction between the strategy approach and style box grids that divide funds based on market capitalization and growth versus value is that AthenaInvest looks at how well a manager sticks to a stated objective, as opposed to how the assets in a fund are invested.
Despite dozens of presentations over the past few years by co-founders Mr. Callahan and C. Thomas Howard, chief executive and director of research, the strategies approach still is climbing the steep side of the mountain in trying to convince intermediaries to think beyond the style box.
“Our biggest hurdle will be the training and helping advisers understand what’s wrong with the boxes,” said M. Wesley Schrader, president of AthenaInvest. “It’s not going to happen overnight, but we think the world will eventually end up looking at fund strategies as opposed to style boxes.”
Style boxes were first introduced by Morningstar Inc. of Chicago in 1992 as a tool for evaluating mutual funds.
The boxes since have been adopted by a range of fund-tracking companies, including New York-based Lipper Inc., which introduced a 12-grid style box in 1999.
Good or bad, the incumbent status of style boxes is expected to present some challenges for a strategies-based system that might seem foreign to financial advisers who have become comfortable with style grids.
“AthenaInvest might have difficulty in educating investors and planners and brokers on strategies-based investing, because style boxes are so easy to understand,” said Jeff Tjornehoj, senior research analyst at Lipper. “It could be a very cool tool, but I don’t know how you move from something like style boxes to something that is much less intuitive.”
Some complaints
Mr. Tjornehoj agrees with some of the AthenaInvest frustrations with style boxes, in that they can restrict managers from investing in stocks that are outside a certain market capitalization or valuation range. But he also said that the boxes serve the purpose of letting people know how a fund is invested.
“I share some of the complaints about style boxes, because some managers should not be constrained to a box,” Mr. Tjornehoj said. “And some managers allow themselves to be pigeonholed by the boxes.”
Another rub against style boxes is the fact that they aren’t consistent from one tracking firm to another, something Mr. Tjornehoj attributes to proprietary research techniques.
The boxes can be particularly troublesome to fund managers that tend to stray from the beaten path.
For example, the Alpha Hedged Strategies Fund was listed as mid-cap growth by Morningstar in 2005, large-cap blend in 2004 and mid-cap growth again in 2003.
The $400 million fund, managed by Lee Schultheis, president of Alternative Investment Partners LLC in White Plains, N.Y., currently is not pegged to any of the Morningstar boxes, which is fine with him.
The fund, he said, applies a hedgelike strategy that involves holding long and short positions, which is something the equity-centered style box grid doesn’t recognize.
“The style boxes don’t even pick up short positions, and that can mislead people,” Mr. Schultheis said. “How a fund behaves is so much more important than how it’s invested, which tells me [that AthenaInvest] is light years ahead of what the style boxes are doing.”
The time for style boxes is over, according to Mr. Howard, who said his research shows that constraining managers to boxes creates a 3% average annual drag on performance.
“It’s the manager’s strategy and the execution of that strategy that generates alpha,” he said. “For any adviser who thinks strategy matters and strategy consistency matters, this is a system that will help to identify those managers.”
The company is withholding certain details of its business model due to a number of pending patents. But representatives did confirm the planned use of diamond ratings to identify managers who are best at sticking to a specific strategy.
“According to our research, if a manager can’t tell you what he does and then focus on that, they tend to not perform well,” said Mr. Howard, a professor at the Reiman School of Finance at the University of Denver’s Daniels School of Business.
