The investment styles of many funds’ actual portfolios vary over time, diverging from their previously stated targets and strategies. The China Securities Regulatory Commission (CSRC) issued a series of policies which introduced restrictions on behaviors like “style drift” and high turnover. However, studies have found that style drift can enhance fund performance. This paper therefore categorizes different types of style drift and examines the issue, which is both academically controversial and at odds with current policies.

This paper selects China’s actively managed open-end funds from 2005 to 2022 as the sample, measures the funds’ industry style drift by the Euclidean distance between the funds and the benchmark, and analyzes its overall impact on fund performance. The results show that style drift generally improves fund performance; however, the CSRC’s regulations place certain constraints on the returns of high-drift funds. This paper further classifies style drift into capability-based and trend-chasing drift. The findings indicate that funds with investment capability significantly improve performance through style drift, though this effect is weakened by regulatory restrictions. Conversely, trend-chasing drift negatively correlates with performance, with regulatory restrictions improving the performance of such funds.

The marginal contributions of this paper are that: First, by differentiating between capability-based and trend-chasing drift behaviors, it provides a new perspective on the economic consequences of style drift. Second, it examines the impact of regulatory policies on fund behavior and performance, offering recommendations for balancing the flexibility and rigor of style drift regulations. Third, it introduces a sector-based method for quantifying style drift, providing theoretical support for regulatory authorities in monitoring fund styles and maintaining the stability of fund risk characteristics.

This paper has practical significance for China’s capital markets by revealing the complex impact of style drift on performance and emphasizing the balance between regulation and flexibility. Although style drift may enhance fund performance under specific conditions, excessive regulatory relaxation could lead to style benchmark instability. To address this, it is recommended that regulatory authorities establish a fund evaluation system to identify high-capability funds, apply stricter oversight on high-risk trend-chasing drift, and allow measured flexibility for rational and analysis-based drift. Investors should also increase their understanding of style drift, assessing funds’ long-term returns and risks rationally to achieve stable financial goals.