2. Solow and Kitces conclude, “Style Analysis along the lines described above – because it is measured on a retrospective basis – unfairly changes a manager’s benchmark itself, after the fact, based on his or her skillful changes to the fund’s asset allocation over time. In other words, returns-based style analysis implicitly assumes that a manager’s benchmark is the same as the manager’s regression-based asset allocation.” (Page 3, paragraph 5)
Returns-based style analysis only reveals the styles where the manager is invested; it cannot magically update a manager’s prospectus or style ex ante at Morningstar or Lipper. Many academics, including Sharpe and Ibbotson, have suggested that a manager’s style allocation should be the manager’s custom index for a more accurate assessment of skill.
The only assumption made by style analysis is that the operator chose the appropriate family of style indexes.
While I clearly agree with Solow and Kitces that Ibbotson’s work undervalues a manager’s allocation decisions, style analysis is not to blame.
Brent E. Bentrim, CIO
Carolopolis Fiduciary Counsel
We appreciate Mr. Bentrim’s response to our letter. In point of fact, it appears that our conclusions are actually quite close – as Bentrim states, “I clearly agree with Solow and Kitces that Ibbotson’s work undervalues a manager’s allocation decisions…” – it may be helpful to clarify a few points further regarding our comments about style analysis.
First and foremost, all of our comments about Return-Based Style Analysis (RSBA) pertained only to their application in the Ibbotson studies. Accordingly, RSBA itself is not a “bad” methodology, but instead Ibbotson’s use of RSBA to determine the amount of a fund manager’s “excess” returns attributable to portfolio policy (versus active management) is problematic. Ibbotson’s methodology causes RSBA to become a de facto benchmark for determining the return of the fund due to its investment policy, such that any deviation of returns is attributable to active management. However, as we tried to illustrate – and Bentrim agrees – RSBA is not necessarily an effective means to determine a benchmark to measure active management.
The reason that RSBA can become a poor benchmark, in turn, was something we attempted to illustrate using the Hussman Fund as an example of a broader problem – that RSBA will, by definition and by virtue of how it is applied in the Ibbotson study, characterize a fund manager’s active management decisions that alter the asset allocation as returns attributable to policy (because they will be present in the RSBA) instead of returns attributable to active management.
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