It is fairly well known that many fund managers adopt specific investment styles in running their portfolios. These are the underlying investment principles and strategies a fund manager favours and this in turn determines their asset and sector allocations and the type of stocks they buy. Whilst the main styles are often described as “value” or “growth,” there are variants, for example a style that is a blend of value and growth, contrarian investing, deep value, bottom up (stock-picking focused), top down (based on macro-economic assessment) and style agnostic. The terminology can be confusing, the boundaries between terms are sometimes blurred and some style terms can be combined for example a fund manager may be described as a bottom up value investor.
So what is the relevance of these styles for investors? First a few definitions.
Value & Growth Investment Styles
This article from Fidelity’s US website describes these as follows:
Growth funds focus on companies that managers believe will experience faster than average growth as measured by revenues, earnings, or cash flow. Growth fund managers also look carefully at the way a company manages its business. For instance, many growth-oriented companies are more likely to reinvest profits in expansion projects or acquisitions, rather than use them to pay out dividends to shareholders.
The goal of value funds is to find proverbial diamonds in the rough; that is, companies whose stock prices don’t necessarily reflect their fundamental worth. The reasons for these stocks being undervalued by the market can vary. Sometimes a company or industry has fallen on hard times. Other times a poor quarterly earnings report or some external event can temporarily depress a company’s stock price and create a longer-term buying opportunity. In searching for these companies, managers look for what many experts call a “margin of safety.” This means that the market has discounted a security more than it should have and that its market value, the price at which it is trading, is less than its intrinsic value, the present value of its future cash flows.
Relevance of Styles
The relevance of investment styles relates to the business cycle. At various times in the cycle certain investment styles, strategies, sectors or stocks are favoured. If a fund manager can call these cycles correctly there is money to be made. To give some historical context before some current examples. The global financial crisis of 2007 and 2008 and the subsequent recession and EuroZone crisis resulted in risk averse sentiment amongst investors. Cyclical sectors like miners tanked and emerging markets were avoided. Instead investors sought the safety of defensive stocks, principally in developed economies, i.e. companies with stable earnings and sustainable dividends as well as safe haven government bonds and strong currencies.
Defensive stocks traditionally include tobacco companies, food retailers, utilities and pharmaceuticals and tend to do relatively well in recessions on the principle people still smoke, eat, use gas and take medicines in a downturn, though hopefully not all at the same time.
Subsequently as the global financial and EuroZone crises abated appetite for risk increased and the sectors and assets that were most oversold rallied. This particularly benefitted economically sensitive cyclical companies, smaller companies, European stocks and bonds, and high yield debt.
The changes in the global economy, investor sentiment and favoured styles have a key bearing of the performance of actively managed funds. Some funds and fund managers have set styles that they do not shift from or shift too slowly from, whilst others are tactically nimble, clever or contrarian, adapt their strategies and call the market well.
Here are some examples I have come across recently:
M&G Recovery – this has a distinct value or deep value investment style, buying and holding out of favour UK companies the fund manager considers the market has not fully appreciated. This style was previously very successful but has led to the M&G Recovery fund underperforming its peer funds in the last five years as defensive growth or cyclical growth stocks have outperformed at different stages. It has also performed poorly as M&A activity (mergers and acquisitions) which benefit recovery stocks has been very muted in recent years especially amongst larger companies. Corporates have been hoarding record levels of cash because of economic uncertainty rather than splashing out on capital expenditure. Now M&A activity is picking up the M&G Recovery fund fortunes may improve.
Schroder UK Absolute Target – this fund seeks to make money in all market conditions by taking long and short positions in UK equities. To remind you a long position is an active investment in a stock or index with an expectation its price will rise. A short position is a bet a stock or index will fall. This fund suffered a 4% loss in March and April due to a sudden sell-off in mid-cap stocks the fund had long positions in. These performed extremely well in 2013. It seems investors decided to take profits and sold out of the mid-cap winners and bought into mega caps. It was a rotation from cyclical stocks to large cap value. Unfortunately Schroder were underweight here and were short on AstraZeneca, which rallied on the initial bid by Pfizer. Other fund managers in contrast pared back mid-cap holdings prior to the correction on the back of valuation concerns.
Standard Life UK Equity Income Unconstrained – this has an excellent track record compared to its peers over one, three and five years. It adopts a contrarian investment strategy by looking for dividends across the market capitalisation spectrum, including smaller and medium sized companies. In contrast traditional equity income funds focus on solid dividend payers within the large and mega cap space. The focus down the scale has resulted in excellent returns for the Standard Life fund.
Old Mutual UK Alpha – Since 2006 banks have gone from aggressive growth stocks and solid dividend payers, to basket cases, some requiring life support and now to recovery stocks. Their balance sheet complexity put off professional investors given fears of hidden toxic debt and the wise principle of not investing in anything you do not understand. However some investors saw the recovery potential and value in selected over-sold stocks and invested early. Veteran fund manager of the Old Mutual UK Alpha, Richard Buxton was one who has benefitted from this contrarian stance. Interestingly the M&G Recovery has recently been underweight in financials which also hurt performance. This sector by the way is broader than banks and includes for example insurance companies and asset managers.
Market conditions and economic cycles play a key role in investment returns. It is not just asset allocating correctly to equities, fixed interest, cash or property, nor stock selection, although these are important. The best fund managers are likely to have a flexible and nimble investment style to take advantage of changing cycles and opportunities.
This blog is intended as general stock market commentary only, not advice to invest in the sectors or funds highlighted. You should seek individual advice before making investment decisions.