Combining Returns Based and Characteristics Based Style Analysis for US Diversified Equity Funds
21 Pages Posted: 12 Sep 2010 Last revised: 4 Aug 2011
Date Written: September 11, 2010
Our study is the first to combine returns based and characteristics based style analysis into a single style analysis model. We use Best Fit Indices to establish the ‘investment domains’ of our sample managers, along the lines of size and ‘style,’ and then use our multidimensional characteristics based analysis to form style groups within those domains. We illustrate how using a combined BFI-CBS methodology (Best Fit Index (BFI) Characteristics Based Style Analysis (CBS)) improves on the out-of-sample forecasting properties of either model on their own. There has been debate in the literature about the relative merits of Returns Based Style (RBSA) analysis and Characteristics Based Style Analysis (CBS) but few of these papers address the issue of whether these methods are contradictory or complementary, preferring to focus on the relative attractiveness of the various methods or any apparent shortcomings. Our study is the first to combine the information into a single style analysis model. The BFI-CBS methodology provides a means of classification of equity investment styles that has academic rigour and is suitable for practical application; with intuitive appeal and empirical support.
Our out of sample tests confirmed two things; membership of style groups formed on the basis of our combined BFI-CBS model explained a significant degree of cross sectional performance of mutual funds and secondly the cumulative effect of combining Best Fit Index and Characteristics Based Style analysis significantly improved on the CBS model and BFI models when reported on their own. The implication being that the ex post explanatory power of the combined model is greater than the individual parts.
Furthermore, qualitative analysis of our results was consistent with investment practice and academic consideration of style and economic exposure with similar characteristics to the qualitative data presented by Christopherson and Williamson (1995) and Brown and Goetzmann (1997).
Keywords: Portfolio Management, Management Style, Style Analysis, Mutual Funds, Portfolio Characteristics, Characteristics Based Style, Returns Based Style, Factor Analysis, Style investing, Comovement, Value, Growth, Investment, Asset management
JEL Classification: G11, G12, G14, G20, G23
Suggested Citation: Suggested Citation