The Dangers in Using Return Based Style Analysis in Asset Allocation

Abstract

The article begins with some background information and presenting the problem faced by the retail investor and the on-line advisor. The authors then formally set up the problem that must be solved in order to give the investor accurate advice. They suggest that, though their experience is predominately within the retirement plan arena, their framework is not limited to this area and argue that, in fact, much of their work may be even more important for taxable investments. They then offer a few examples of why strictly quantitative methodologies cannot be used blindly by on-line advisors when offering advice. They subsequently present a remedy to the drawbacks associated with the strictly quantitative approaches: a fundamental analysis focused on qualitative as well as quantitative factors. They argue that fundamental analysis establishes correct and stable style exposures of the funds being analyzed. They illustrate the potentially severe differences in outcomes depending upon which methodology is used in selecting individual funds.