Style Migration and Industry Evolution
Authors: Chen Hsiu‐Lang 
Published: January 2008

This paper investigates whether style migration affects industry evolution. The study documents industry evolution in terms of market weights, returns, and risks over the sample period from 1966 to 2000. The study shows that investment styles migrate in different degrees across different industries over time. In addition, the relation between industry evolution and style migration is neither simple nor static. The paper shows that growth‐value migration has predictability about the industries' returns and changes in volatility. Furthermore, style migration in the industry is mainly driven by existing firms changing their investment styles, not by new entrants to the industry causing style shifts. Both investment theory and its application to investment management critically depend on our understanding of stock return persistence anomalies. The ability to outperform buy‐and‐hold strategies by acquiring past winning stocks and selling past losing stocks, commonly referred to as “individual stock momentum,” remains one of the most puzzling of these anomalies. Moskowitz and Grinblatt (1999) attribute the bulk of the observed momentum in individual stock returns to industry momentum—the tendency for stock return patterns at the industry level to persist. It is well known that there are hot and cold IPO markets, and hot and cold sectors of the economy. Investors may simply herd toward (away from) these hot (cold) industries and sectors, causing price pressure that could create return persistence. The recent attraction to internet stocks is perhaps the latest manifestation of such behavior, which is not unlike a similar pattern biotechnology firms and railroad firms witnessed in 1980s and 1900s, respectively. For the active portfolio manager, rotation among different industries may provide opportunities for portfolio performance enhancement. As a result, understanding both the evolution of industries and the style factors causing cyclical variation in industry returns and risk plays an important role in professional portfolio management. Given the fact that a number of researchers have found consistent differences among the returns of various equity classes, investment styles of size and growth‐value are natural candidates for studying what causes cyclical variation in industry returns and risks. Individual investment styles perform differently during various stages of a cycle of bull market and bear market. For example, small cap stocks outperformed large cap stocks in the 1970s, but large cap stocks outperformed small cap stocks in the 1980s. Growth stocks outperformed value stocks in 1998 while the opposite occurred in 1997. Although it is well documented that the cross‐sectional variation in expected returns can be captured by three factors: market, size, and book‐to‐market, it is not yet clear whether cyclical variations in style attributes, not style returns, influence cross‐sectional variation in expected returns and return variance. In the investment industry, cyclical variation in style attributes is commonly called style migration. Perez‐Quiros and Timmermann (2000) provide a rational suggestion that small firms are most strongly affected by tighter credit market conditions in a recession and thus cyclical variations in style performance result from business cycles. As certain equity classes took off and others fell out of favor, investors overreacted, thereby causing cyclical variations in returns and risks of industries where firms are similarly sensitive to the fundamental shocks. In a recent study of behavioral finance, Barberis and Shleifer (2003) argue that in the presence of switchers who can affect asset prices by moving funds across styles, a style‐level momentum strategy could be successful because good performance by a style attracts switcher flows, which then drive the prices even higher. Analyzing the extent of interaction between style migrations and industry evolution may shed light on understanding the sources of predictable components in industry returns and risk. This paper provides such a contribution to the literature. The rest of the paper is organized as follows. Section I describes the sample data and summarizes industry evolution in terms of market capitalization weights in the entire market over time. Section II analyzes style migration within each industry. Section III examines the effect of style migration on industry evolution. Section IV concludes.