Some comments on and lessons from this example are:
Consultants and managers can have very different beliefs about what is important, about what information is valid, and about what kinds of information define a manager's style. Consultants are concerned with classification of managers so performance can be assessed relative to a benchmark or peer group and multi-manager portfolios can be constructed to ensure a certain spectrum of market coverage. "Style consistency" for the consultant means having stable measures for those financial ratios that define style boxes. Managers are primarily concerned with exploiting their skill to find undervalued securities, and the intersection of skill and opportunity does not necessarily produce stable financial ratios through time. To many managers it is puzzling why that should be important.
A key mechanism by which culturally-based belief systems sustain themselves is the socialization and sorting of new members of the cultural group. An important part of this can be the "stripping down" of new members who, often inadvertently, violate the norms of the culture. Such new members will usually either adapt to the norms or exit the group, so that surviving members of the group share the norms, and validate them for each other. This sorting and subsequent social validation is a key reason why cultures resist change.
Social validation of a culture's beliefs does not necessarily mean that such beliefs contribute to the environmental competitiveness of the culture. In the case of style boxes, a key dysfunction derives from their encouraging uneconomic buying and selling of securities. For example, our value manager may feel pressed to sell a stock before the thesis has fully played out to insure that she still plots in her style box. This creates an incentive for managers not constrained by style boxes (e.g. hedge funds) to pick up the money left on the table by style-box managers. Although there are presumably many reasons for the rise of hedge funds in recent years, one reason may be the opportunity for flexible, skill-based investing left unexploited by managers constrained by style boxes. The poor performance of tightly constrained portfolios also puts pressure on the business model of consultants advocating such approaches. Interestingly, many consultants formerly constrained by the style box framework have now embraced "alternatives" due to their superior risk/return characteristics.1
Holdings-based style analysis is extremely useful, but the rigid use of it can be a crutch. I would never have come to understand the value manager described above as well as I did if holdings-based analysis didn't raise some questions for me. However, one has to wonder if the prevalence of rigidly-defined style boxes is due to their giving consultants a sense of purpose, a "substitute problem" if you will, which diverts attention from the real problem – finding talented investment managers and building sensible portfolios of them – which may be beyond the consultant's reach.2
The balance of cultures in a money management firm can be influenced by consultants and clients. It has often been noted that some investment management firms have an investing culture and others have an asset-gathering culture. This is an accurate observation, but I would add that some investment firms have both an investing subculture and an asset-gathering subculture existing in tension with each other. While one will likely dominate at any point in time given the direction from the top, as a firm's environment changes, there may be opportunities for the latent subculture to assert itself. Consultants and clients, as key elements of a manager’s environment, are in position to influence the balance between subcultures. I believe that a rigid adherence to the style box framework on the part of consultants tips the balance of money manager cultures towards asset-gathering.
1. Unconstrained investing has its own challenges, not the least of which is the risk that managers and consultants will operate outside of their skill set. Another challenge is determining the appropriate benchmarks for evaluating performance.
2. A possible middle-ground between rigid style boxes and unconstrained investing is discussed by Ron Surz in a separate chapter of the forthcoming book.
