Style Classification

Style Classification | Definition

The probabilities of group membership at each decision point in the multiple chains of classification reasoning. The basic building blocks of the classification process are each manager's portfolio characteristics relative to the large cap market. Given a manager's key portfolio characteristics, such as price to book, RSC establishes a link between a specific level of price to book and a specific probability of style of management.

About 70% of the value managers in Russell's Large Capitalization Value Universe have a P/B lower than about 1.7 standard deviations below the market, and only 4% have a P/B lower than 3 standard deviations below the market. Consequently, it is reasonable to say that for a manager who has a P/B equal to -0.3 sigma, the probability that he/she is a value manager is about 10%. Furthermore, for a manager who has a P/B equal to -3.0 sigma, the probability of being a value manager is 100%. In other words, the lower the P/B, the higher the probability the manager uses a value investment style. Examination of Russell's growth universes shows a similar cumulative frequency distribution of P/B. The same logic applies to the relationship between values of P/B and the probability of a manager being classified as a growth manager.

Market-oriented managers can be expected to have market-level P/Bs and be approximately normally distributed around the mean. As the manager's P/B moves away from the market in either direction, the probability of being a market-oriented manager decreases.

Given the distributions of P/B in the style universes, the Frank Russell Company has determined that the relationship between portfolio characteristics and the probabilities of a style membership are inherently nonlinear. The probability that a manager is a value manager increases as the price to book drops below the market-level price to book, but it does not decline in a linear fashion; in other words, the probability of value classification does not increase 5% as the price to book drops 5% below market. Rather, the probability of market-oriented membership remains fairly constant as long as the price-to-book is reasonably close to market. But, as the price to book moves away from the flat spot around the market mean, the probability of value style climbs very rapidly and, conversely, the market-oriented probability drops off rapidly.

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