The Problematic 'Style' Grid

Current practice has equity managers being hired to represent a particular "style" box limiting them to stocks with characteristics fitting that box, for example, small-cap value or large-cap growth. An extensive literature search reveals that this system has no empirical basis but simply evolved out of convenience. Along the way, assumptions essential to its validity were made and believed to be true without empirical support. In using the multispecialist system, the words "style" and "characteristics" are currently used synonymously. We distinguish between the two and argue that small-cap value, for example, is neither a style of investing nor an asset class but simply a box in the characteristic grid. We conclude that to produce superior returns, managers must be allowed to pursue unique styles and have access to the entire stock universe, which means that resulting portfolios experience characteristic drift. Furthermore, our empirical results, based on style constancy, show that characteristic-constrained investing sets the stage for underperformance