Have you ever stopped to consider the different types of ‘investment styles’ that constitute the assets making up your investment portfolio?
Or perhaps more to the point – have you ever stopped to consider that having a better understanding of investment styles could help you develop a better, stronger and more productive relationship with your wealth manager?
In this blog post, we’ll discuss the most common investment styles used by asset managers today, the benefits that come with having a more well-rounded understanding of how style investing affects portfolio construction, and the types of questions you should feel comfortable asking your advisor the next time you sit down with him or her for a portfolio review.
What is an investing style?
An investing style, also commonly referred to as the investment philosophy or investment strategy, is the portfolio manager’s approach to building portfolios. It sets the overarching investment discipline and identifies certain qualities or characteristics the manager is look for when analyzing potential investments. The investment style defines how the wealth manager will achieve the portfolio’s investment goals.
Investment styles can be divided, and further sub-divided, in a number of different ways. Our focus today will be on the two most popular dimensions: the value vs. growth investment style and market capitalization investment style.
Understanding the “value” and “growth” styles of investing
By now you may already be familiar with certain professional money managers who will adhere to – and even market themselves as – following a strict investment discipline.
These disciplines have traditionally fallen under either the “value” or “growth” style of investing.
The value style of investing has been gaining prominence and widespread adoption particularly since the 1990’s thanks in large part to the research of 2013 Nobel Prize winner Eugene Fama and his partner Kenneth French and their revolutionary work to develop the now widely recognized Fama-French model.
Essentially, the model suggests that the shares of companies with low P/E ratios, high dividend yields and that offer a conservative relationship between their market values and value of the shareholder’s equity on their balance sheets will tend to outperform the market over long periods of time.
As well, the argument in support of value investing has certainly been helped by Warren Buffett, the world’s most famous and successful investor, who was mentored under the instruction of the late Benjamin Graham, who many investors still refer to this day as the “Father of Value Investing.”
Yet there are many other investors out there who will instead opt to follow a much different, if almost opposite, approach to finding undervalued investments.
Rather than focusing their efforts on developing forecasts for next year’s earnings or the expected value of a dividend to be received today, these “growth” investors will instead often take a step back from where the company is today, in order to try and gain a better perspective of “the big picture.”
Growth investors will often be willing to look past what some value investors may consider as “unreasonable valuations” based on a firm’s current earnings with a view to what that company might look like ten years from now – or in some cases even potentially further down the road.
As the manager of the Magellan Fund at Fidelity Investments, world-famous growth investor Peter Lynch averaged a 29.2% annual return for his clients between 1977 and 1990, consistently more than doubling the returns of the S&P 500 during that period.
And still, there are even other managers out there who may opt for a more balanced approach that employs a combination of the philosophies present under both the value and growth style of investing.
This “hybrid” style of investing is commonly referred to by those working within the industry as “GARP” or “Growth at a Reasonable Price.”
Meanwhile, investments which don’t fall neatly into either the value or growth category are often referred to as being either “core” or “blend” investments.
Investing styles by market cap
Market capitalization of a company is the dollar value of the company’s outstanding shares and it is often used as a synonym for the size of the company.
For example, there are “large-cap” stocks – stocks of multi-billion-dollar companies like Microsoft, Google, or Amazon.
Then there are “mid-cap” stocks – companies like Canadian Tire would fall into this range.
There are even “small-cap” and “micro-cap” stocks – stocks of companies with market capitalizations typically less than $1 billion and sometimes even under $100 million – companies this size will oftentimes carry with them a heightened degree of uncertainty, or risk.
Just as some portfolio managers focus on value or growth companies, believing one style will deliver better results over time, some portfolio managers believe the size of the company will have an effect on returns.
A better understanding of how investing styles fit into the investment management process can not only help to give investors a greater feeling of control over their financial future but can also be instrumental in facilitating a more open and transparent client-manager relationship.
How a better understanding of investing styles can help to foster a stronger relationship with your wealth manager
At this point, you might be thinking there’s a particular investment style – or perhaps even multiple investment styles – that you have more confidence in than others.
Maybe you’re intent on finding the next Netflix, Amazon, or Shopify, Canada’s own e-commerce leader.
Maybe you have a family member or close friend who’s already convinced you of the battle-tested philosophy behind a value investing strategy.
Or maybe you don’t have particularly strong feelings on the matter at all, and you’re more than content to leave those types of decisions in the hands of the investment manager you’ve entrusted your savings to.
Ultimately, when both the client and the manager have a clear and honest understanding of how investment styles fit into the framework of portfolio construction and achieving the investor’s desired objectives, everyone wins.
The next time you’re sitting down with your advisor, consider asking him or her about the investment philosophy behind their investment decision-making process and how investment styles fit into that process.
You may also want to consider asking your advisor to provide you with a ‘style box’ designed to visually represent your portfolio across certain style categories including size as well as the degree to which your investments contain qualities that are typically sought after by those adhering to either a value or growth framework.
In following this approach, you will not only come away with a more informed understanding of the different types of investments that make up your portfolio, but you will also receive valuable feedback on how closely your investment manager is paying attention to this important aspect of portfolio construction.
We believe all Canadians should have a safe place to ask questions.
We’re finance nerds who want to share our love of wealth management with Canadians. Our experience has taught us that many Canadians don’t have a resource to turn to when they want to make a wealth management change or simply want to know more about the Canadian investment landscape. Whether you’re an experienced investor or a beginner we’d love to hear from you to see how we might be able to help you out.
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