Midland AM says constraining managers by style distorts risk-return equation. Dallas-based RIA Midland Asset Management has decided to discontinue the use of "style-box" approaches in client portfolios "in favor of managers who think independently and are not 'closet' index funds," the firm says.

Style-box investing -- allocating assets on the basis of managers' style preferences ("large value," "small growth," etc.) adds little over index investing in terms of the risk-return equation, says Midland's founder and principal Christopher Holtby.

On track

Style-box investing became popular when the Employee Retirement Income Security Act of 1974 demanded that investment managers and consultants act as co-fiduciaries to the non-profits they advised. As a result, consultants began creating risk-return metrics based on these styles. This helped create portfolios that were analyzed, reviewed and graded on risk-return against style indices.

Midland's decision to work with managers who eschew style boxes is based on academic and real-world research. A study by Chicago-based consulting firm Ennis Knupp holds that style-box approaches under-perform indexes by more than 1.2% every year. Another study by the University of Maryland shows that investment managers who step out of the confines of the style box outperform those that use style-box approaches by 290 basis points per year over 15 years.

"I don't want a great stock picker to be confined to, say, large value," says Holtby. "I just want them out there picking undervalued stocks."

Holtby describes Midland as an "outsourced family office." The firm provides "externally sourced" estate, tax, insurance and concierge services and manages portfolios in-house, based in in-house research and due diligence. The firm works with 15 families with an average net worth of $12 million.

Right now Midland has a universe of 12 to 14 traditional and alternative managers that meet the firm's criteria for independence and for not being "closet" index funds.

"We're not trying to be fancy," says Holtby. "We're just trying to keep our clients wealthy and keep them going where they want to go." -FWR

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