The low-down - Too much style is not a good look

Fund managers invest in different ways to take advantage of pricing inefficiencies to capture return. Each investment style provides a different performance journey. By blending managers with different styles the end result can be a smoother journey.  This low-down provides an overview of three common styles – value, growth and market neutral – and how a multi-manager blends these styles together.

Value Managers

Value managers invest in companies whose share prices they believe are undervalued.

Shares that are ignored or out of favour with the market are popular with value managers. These managers aim to exploit a fall in the price of shares in companies where they see potential for a recovery. The potential for recovery is crucial. There is no point buying in at a cheap price if the price does not improve or, worse still, keeps falling.

Value investing has a strong focus on quantitative criteria such as the Price/Earnings ratio (P/E), dividend yield and cashflow of the company. The P/E ratio is calculated by dividing a company’s share price by earnings per share. A value manager will be attracted to companies with a lower relative P/E ratio because it indicates a below average valuation of the company.

Value managers tend to outperform in ‘bear’ markets, where prices are falling or flat for a continued period. Having said that, value has outperformed over the course of the most recent ‘bull’ run due to the underpricing of companies following the aftermath of the technology boom of the late 1990’s.

Growth Managers

Growth managers look for companies with the potential to grow faster than the market because of rapidly growing sales, revenue and profit. This growth should translate to higher share prices.

The growth potential of these companies is why growth managers are willing to pay a higher price for each share than the market average, relative to peers.

Growth investing has a strong focus on qualitative criteria. This includes value judgements about the company, the

market it is in, the quality of management and the future earnings potential of the company. Growth managers look for companies with higher P/E ratios, reflective of higher earnings potential.

Growth managers tend to outperform in ‘bull’ markets, where prices are rising strongly.

Market Orientated Managers

There are many variations of manager styles between the extremes of value and growth. Market orientated managers are common. These managers display no preference for a particular style when looking for investment opportunities.

Market orientated managers tend to move across the value and growth spectrum. Characteristics of one style may dominate their portfolio depending on market conditions. This is an outcome of share selection rather than the manager intentionally tilting their portfolio to a particular style.

So which style?

Each style adds value at different times over the market cycle. In the long run, both value and growth should add value, however the performance can be lumpy and unpredictable. The chart below shows the difference in quarterly performance of the style indices, value and growth (MSCI World) since their inception in 1999 to the end of March 2007. Value and growth shares have outperformed at different times. Growth shares dominated during the technology boom of the late 1990’s, since then value shares have been more rewarding.

Exposure to a blend of styles protects investors when a particular style is out of favour while still providing some of the upside when styles do well. The result of blending investment styles is a more consistent investment journey relative to benchmark returns.

The benefits of a multi-manager

Historically, many investors placed their investments with a single manager. As the importance of diversification has become better understood, investors have spread their investments across two or more managers to access different sources of return from managers with specialist skills. Choosing more than one manager also reduces the risk of making the wrong choice. An effective way to achieve manager diversification is through utilising the skills and experience of a multi-manager expert.

A multi-manager does not invest directly; rather they invest with a number of specialist managers in each asset class who trade a portfolio of securities on their behalf.

The blend within a multi-manager portfolio has the potential to reduce volatility and produce more consistent returns relative to benchmark returns. The following chart shows the excess rolling returns of an international share growth manager, value manager, market orientated manager and a blend, a multi-manager. The excess return is the return greater than the index (MSCI World). For the three-year period to 31 December 2006, the index returned 12.7% p.a. compared to the blend portfolio which returned 14.5%.

In real life

While in theory it looks like blending works to provide consistent returns, does the theory work in practice?

The chart below shows the consistency provided by a blend of two Hong Kong share managers , AGI and Schroder. The blended portfolio avoids the peaks and troughs of style orientated approaches while still capturing long-term outperformance.

Conclusion

Experience suggests that many investors find it hard to stay invested during the low points that can occur if you invest in just one style. The more consistent return of a multi-manager makes investors more likely to stay on the journey and benefit from the longer-term performance of market.

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