Share fund managers generally adopt a particular investment style and different investment styles can perform well in different market environments.
So, what is the best investment style for the current environment? This isn’t an easy question to answer and the process is complicated by the ever-expanding range of investment styles.
Some of the key investment styles on offer from fund managers include:
• Value investors – Which aim to generate performance by purchasing shares when they are below ‘fair value’ using a range of valuation methodologies including discounted cash flow analysis, price/earnings multiples, priceto- book values or dividend yield.
• Growth investors – Aim to generate returns from allocating money to companies that exhibit superior growth of earnings, with less emphasis on the valuation (typically reflected in higher price-to-earnings ratios relative to the market).
• GARP (Growth-At-a-Reasonable Price) investors – which sit somewhere in between the two styles above. These investors are looking for companies with the potential to generate superior earnings growth, but are also very conscious of the valuation.
• Quality investors – which aim to invest in the best quality companies assessed on the basis of factors such as returns on equity, stability of earnings, balance sheet health, stability of management, transparency of disclosure to investors and strength of the business model. Higher quality companies can also have either value and/or growth characteristics.
• Style-neutral investors – which aim to remain neutral to any particular styles with a blend of value and growth characteristics. Even within this grouping there can be variations. There are those investors which aim to maintain an even balance over time and not exhibit any style bias and then there are style-neutral investors which actively allocate between the styles and will implement style tilts over time, depending on market conditions.
The variation in returns across styles can be significant during the shorter to medium term. . Therefore, it is important to be aware of the market conditions best suited to each style. Successful style-neutral strategies can be attractive in all market conditions (excluding extreme bull markets where active fund managers typically struggle to outperform), but there may be times when a tilt to value or growth may be appropriate.
Over the past twelve months the Australian equity market has seen a significant rotation away from value stocks into growth, quality and momentum stocks. This has pushed up the price of growth stocks, particularly those in the IT sector, those with strong price momentum and those companies with exposure to offshore earnings. On the other hand, some out-of-favour value stocks such as miners and banks have struggled with higher operating costs and greater regulatory scrutiny respectively.
However, the underperformance of value stocks may not persist, particularly if growth stocks fail to deliver on their lofty growth expectations or equity markets enter a more difficult period which could see growth and momentum stocks fall far more than dividend-paying value stocks, which suggests it may be prudent to maintain a more balanced or style-neutral approach to equity investing.
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