What are the investment styles a manager may follow?

Key takeaways

  • Certain common investment strategies that managers follow are called investment styles.
  • Markets reward different investment styles with good returns at different times in the economic cycle.
  • Understanding your manager’s investment style will help you understand when it will deliver good returns and when it may underperform.
  • Investing with managers with complementary investment styles can help smooth the returns you earn.
  • The most common investment styles for equity managers are growth and value.
  • Growth managers generally seek out shares that are growing their earnings and hence their share price.
  • Value managers generally seek out shares that are trading below what the manager believes is their fair price. The manager will hold the share until it returns to fair value.


Style has a specific meaning in investment terms, and is an important part of successful investing.

Investment managers are said to follow a particular investment style when their investment philosophies and strategies align with ones identified by the investment industry.

Markets reward different investment styles at different times and this is why it can be useful to identify a managers’ style and understand when it will deliver good returns and when it may underperform the market.

If you plan to invest with more than one manager to diversify your investments, it is also useful to identify a manager’s style to make sure you blend complementary manager styles in your portfolio.

The different investment styles are:
 

Growth style

What it is: A growth-style manager generally selects shares that have good prospects to grow their earnings – typically the so-called growth shares.

The manager researches companies looking at the business and its cashflow to see if earnings and dividends are likely to grow.

If these projections are correct, the price should go up.

Growth-style investments tend to do well when the market is trending up.

Tend to do well when: the market is doing well and the economy is booming.

Variations: A variation of the growth style is managers who in growth at a reasonable price – they do not invest in an shares with good earnings growth, but only those whose price is reasonable relative to those earnings.

Characteristics of a growth share:

  • Strong profit growth,
  • High earnings per share,
  • High revisions of earnings;
  • Expensive relative to other shares on the market;
  • High return on equity above the cost of capital.
  • High price-to-earnings ratio;
  • High price-to-book ratio;
  • Low or non-existent dividend yield.

 
Value and valuation style

What is it: A value-style manager selects shares that are undervalued, or cheap relative to what the manager determines is their fair value or the break-up value of the company. This is also referred to as the intrinsic value of the company.

Value managers choose these shares because they believe the shares will, at some point in the future, return to their fair value.

These managers are said to invest with a “margin of safety” or price discount. Not paying the full price for a share, means the likelihood of incurring losses are minimised.

Value style managers tend to invest for the long term and do not trade shares actively. They are often said to be "contrarian" as they go against the herd and avoid current investment themes or trends.

Value style managers are often high-conviction managers who prefer small, concentrated portfolios that are quite different to the benchmark or their competitors.

Tend to do well when: the market is slowing down or when the economy is in a downturn.

Variations: Some managers refer to themselves as valuation style managers as the shares in which they invest are not necessarily be cheap, but relative to expected earnings the price is low (a low price-to-earnings ratio).

Deep value managers look for very undervalued businesses or sectors of the market which can stay out of favour for long periods before recovering.

Characteristics of a value share:

  • Low price-to-earnings ratio;
  • Low price-to-book ratio;
  • Low price-to-sales ratio; and
  • High dividend yield.

The value and growth styles have often been misrepresented as opposite ends of a market cycle, but while there are cycles in the market during which growth shares may do better than value shares and vice versa, there are also times when both styles do well or badly.


Other styles

Momentum style

These managers invest in shares whose prices are rising. They may buy heavily into popular investment trends or themes with less consideration for the underlying company.

They are likely to trade shares more on shorter-term views than other managers with longer-term buy and hold views. They may buy shares that are not particularly cheap as they expect the price will continue to rise for three, six or 12 months.


Quality

Managers who invest well managed businesses with strong balance sheets, strong cashflows, and a competitive edge, are said to follow the quality style of investing.


Small and mid-cap

Most managers know and invest in larger shares, but some managers specialise in investing in mid-or small-cap shares as they are less well-researched allowing the manager to gain an information advantage.

These shares tend to outperform when markets are trending up and underperform when markets are falling. They are considered to be more risky than shares with a larger market capitalisation.


Style matters

If a manager says it follows a style, you should expect it to perform well at certain times in line with the cycles in the market. Comparing managers with different styles should give you insights into whether a manager is performing as expected.

For example, a value manager may be performing below a benchmark when a growth manager is above benchmark over the same period.

When you use an active manager, you should expect its active decisions to result in it underperforming at times and you should evaluate its performance in the context of the investment style and term over which the manager has stated it aims to deliver returns above its benchmark.

Over short and sometimes over extended periods there can be significant divergence in performance of managers with different investment styles. These divergences do correct over time - sometimes over many years.


Cramping style

Some managers argue that the size of the South African market makes style distinctions difficult, especially for large managers.

In small concentrated markets like South Africa, managers with large amounts of assets under management may be forced to invest largely in the largest companies rather than choose to invest based purely on value or growth characteristics.