Suits you sir? Why your investment manager’s style is so important

28th September 2010

The two main investment styles are value and growth.

Generally speaking, a growth-oriented portfolio will contain companies that the fund manager believes have the potential to increase earnings faster than the rest of the market. These will typically have a higher PE ratio and lower dividend yield than value stocks.

By contrast, a value manager will focus on companies that they think are undervalued in price and that will eventually see their true worth recognised by the market. These will normally have a lower PE ratio and higher dividend yield than growth stocks.

Few managers fall neatly into one camp or the other as most will have developed their own unique investment style.

The adviser's perspective

James Davies from independent financial adviser Chartwell says that some of the larger investment companies will tend to have an overriding house style, whereas the smaller firms will often allow the individual fund managers to follow their own approach.

"The manager's investment style is one of the key things we look at. When building a diversified portfolio you want to make sure you have exposure to a range of different styles."

The reason for this is that one style will tend to perform better than another at different points in the economic cycle . Knowing the manager's approach should therefore help you to understand his past performance.

"A manager that focuses on unloved, distressed stocks would probably do well at the low point in the market as sentiment picks up. Likewise, someone who concentrates on the fundamentals and invests in solid companies would be expected to outperform in a bear market," he adds.

Value bias

Dan Roberts, manager of the Gartmore UK Equity Income Fund, is a firm believer that value will outperform growth over any reasonable timeframe. This reflects his view that the most important driver of returns from an investment is the initial price you pay.

He cautions, however, that the label "value" means different things to different people. "It is not as simple as just looking for low PE or high yielding stocks. I try to work out what a company can achieve going forward, while being mindful of where we are in the economic cycle."

Roberts uses a screening tool based on a number of different metrics to generate ideas for further research. He then looks into the fundamentals in more detail and meets the management before deciding whether to invest.

"I look at what the company has achieved historically so as to get an idea of the returns in different parts of the cycle. I also take into account other important considerations such as the competitive environment, the nature of the product and market."

Roberts typically has 45 to 50 stocks in his portfolio and pays little heed to the index weightings. "I am a bottom up stock picker with a value style and let the valuations take me to the relevant parts of the market."

Refined style

Alec Letchfield, CIO Wealth (UK) Private Client Business at HSBC Global Asset Management, says he and his team apply a style screen as part of their investment process and then look at more qualitative factors before deciding whether to buy.

"The overriding style that is prevalent in many of our funds is based on a combination of two metrics: a high return on capital that covers the company's cost of capital and an attractive valuation based on the underlying cash flow."

Letchfield adopted this approach back in 2003 after back testing the performance of all the different investment styles. Their research showed that the combination of these two factors generated some of the most consistent returns over time.

"We use the style screen as a discipline but are not necessarily beholden to it, although the bulk of our holdings exhibit these characteristics. A significant proportion of the overall portfolio return is due to the investment style," explains Letchfield.

Another core feature of their approach is conviction investing, where the manager holds a small number of high conviction positions. To put this into context, the HSBC UK Focus Fund runs 28 to 36 names, whereas a typical institutional fund would normally be much more benchmark orientated.

"We think you should either be passive and cheap like an index-tracking ETF, or if you are charging an active management fee then the performance should justify it," explains Letchfield.

Above average returns at below average risk

The Schroder UK equity desk uses a number of different approaches. This reflects the fact that they have a large investment team, which allows the fund managers to benefit from the collective insight of a tightly integrated group of leading in-house analysts.

As part of the wider team, the specialist value desk follows a distinct and disciplined value approach across each of their portfolios. The men in charge are Nick Kirrage and Kevin Murphy, the co-managers of the Schroder Income and Schroder Recovery funds.

"We manage money in a value-oriented, long-term, income style. This means we look for UK companies that have been mispriced by the market and in our view offer good value over the long term," explains Murphy.

The term value investing can loosely be described as the practice of exploiting the market's mood swings by purchasing securities at less than their true worth and waiting for the valuation to correct.

According to Murphy, this means that value investors tend to be; contrarian, have a long-term investment view, and accept that periodic underperformance is a natural feature of their investment style.

"We believe that value investing works over long periods of time, producing above average returns with below average risk," he says.

Leave a Reply

Your email address will not be published. Required fields are marked *