A Canadian private wealth manager observes that, over the past three years, a client's actively managed "Canadian Balanced" portfolio, which is supposed to hold 60% equities and 40% fixed income, consistently shows a correlation of 0.85 with the S&P/TSX SmallCap Index. What might this indicate?

Question: A Canadian private wealth manager observes that, over the past three years, a client's actively managed "Canadian Balanced" portfolio, which is supposed to hold 60% equities and 40% fixed income, consistently shows a correlation of 0.85 with the S&P/TSX SmallCap Index. What might this indicate?

Answer options:

• The portfolio manager has successfully diversified the equity component. ✅ The portfolio is exhibiting significant style drift towards Canadian small-cap equities.
• The fixed income component is providing strong downside protection.
• The benchmark being used for performance evaluation is inappropriate.

Correct answer: The portfolio is exhibiting significant style drift towards Canadian small-cap equities.

Explanation: A high correlation with the S&P/TSX SmallCap Index, despite being labelled 'Canadian Balanced' with a large-cap equity expectation, strongly suggests that the portfolio's equity component has drifted towards small-cap investments, indicating style drift.