30 October 2007
By Tim Hewson
As the tidal sands of the global markets continue to shift, now is the time for investors to consider the importance of Investment Style.
In the past we discussed the importance of setting objectives, understanding your pain threshold, diversification benefits and the advantages of employing dynamic, strategic and tactical asset allocation.
However, in order to integrate these concepts and put them into perspective, we must also understand the different types of investment styles available and how they can help investors achieve their investment goals.
Everyone's style is different
Firstly, it's important to acknowledge that different investment styles perform in their own ways in various and changing market conditions, and will therefore suit some investors but not others. At the very least, investment styles can help investors better manage their expectations.
Whilst many funds might appear to be similar, not all funds are the same and it is typically the fund manager's investment style, which separates one fund manager from another.
An investment style could be considered much the same as an investment philosophy. They usually represent a set of theoretical guidelines, which ultimately determine the boundaries of a fund managers decision making capacity, or the constraints that they must operate within, when managing money on behalf of investors.
Since investment styles are an important consideration for investors, ensuring a fund manager sticks to the nominated investment strategy is also important as it allows you to more accurately align their style with that of your own.
Which style suits you?
There are three major types of investment styles -
Growth styles
As the name suggests, fund managers focused on growth, typically look for investment opportunities with the greatest potential to grow in value. They usually buy potential growth investments and sell the ones that are expected to under perform relative to other opportunities.
An example of a typical growth strategy is a fund that invests in equities or shares. In this instance, fund managers seeking growth will look for shares with above average earnings and stocks with the greatest potential for profit. Put more simply, fund managers will invest in shares with a high Price to Earnings ratio (P/E), strong balance sheet, effective debt management and a solid track record.
The obvious benefit of growth strategies is their potential for upside capital appreciation. A fund manager can also provide investors with diversified access to a portfolio of growth-focused investments, by spreading money across multiple investments.
Of course, there is also the possibility that growth will not materialise, the investment will under perform the broader market, or that the successful growth manager will attract attention, leading to momentum buying, which drives down capital growth.
Value styles
In contrast, value based strategies have been favoured since the tech wreck and the excessive and unsustainable valuations of the 1990's.
Usually less volatile than growth strategies, value based strategies tend to take a longer term view on market cycles, and are less volatile in their buying and selling behaviour throughout peak and trough cycles.
Value managers typically purchase investments at discounted or undervalued prices, and expect to turn a profit based on their analysis of potential earnings growth, high cash flows and a low P/E. While this investment style is often accused of having a negative short-term impact on prices, value investors also run the risk of bargain stock staying at low prices for other reasons. Namely market misprising, poor timing and inflated expectations.
Growth at a Reasonable Price (GARP) styles
In contrast to growth and value managers, style-neutral GARP managers believe they can exploit both styles as they seek opportunities for undervalued investments that have perceived potential for sustainable long-term growth.
Often useful when the market becomes volatile, this style lets managers trade in and out of various under or over performing stocks, make more defensive investments and look for longer term opportunities.
However, the major challenge for these managers is managing both strategies during volatile market conditions. In a sharply declining market, where growth stocks are likely to lose capital value quickly, P/E expectations rescind and it can become increasingly difficult to implement a values based approach.
A mix and match of styles
It is important to remember that each style has its own application during various market conditions. Importantly, certain styles will also suit some investors and not others.
The confident investor is unlikely to place all investments into just one strategy and most analysts recommended using a combination.
Utilising the principle of diversification, investors can also combine growth, value or GARP styles with other types of investment strategies. These might be asset class specific, more sector driven, thematic, focus on cycles, or even index specific.
The alternative is to consider multi-manager funds that employ a multi-style strategy. Similar to outsourcing the investment decision making process and investing indirectly via managed funds, multi-manager funds offer investors instant diversification across the various options.
A multi-manager typically makes several allocations across a number of fund managers each specialising in a particular asset class, investment strategy or style.
Whilst many typically think of multi-manager products as being defensive, multi-manager funds can have a bias to growth or value strategies. In either case, multi-manager funds often take the headache out of having to research, analyse, compare, select, invest and monitor multiple investments within your portfolio, and provide a useful addition to a diversified portfolio in their own right.
Investing...it's all about style!
Thanks for reading, see you next time.