Understanding Investment Styles

Written and accurate as at: 9 March 2016

Have you ever wondered how portfolio managers make decisions when it comes to managing a portfolio of shares?

Share investors tend to fall into two basic categories: active and indexed.

Indexed investors generally aim to perform in-line with a market index, such as the S&P/ASX200 or the Dow Jones index, by constructing their portfolios to mirror the relevant market index.

Active investors build their portfolios with the aim of outperforming the market over a particular period. Their approach will generally be guided by a philosophy or style they apply to investing. The two most common styles of share investing are value and growth, but some investors take a hybrid approach that combines elements of both.

A value style focuses on companies the investor believes are undervalued; that is, where the share price does not reflect the actual value of the company. Shares for these companies generally have a low share price relative to earnings and/or dividends (a low price-to-earnings ratio or a high dividend yield). Investors with shares in value companies believe in the high potential of their businesses and are prepared to wait patiently. American billionaire Warren Buffett is well known for his value investment style.

A growth investment style is quite different. Here the focus is on companies that are expected to experience faster than average growth. Shares for growth companies generally have high price-to-earnings ratios and low dividend yields. This might include companies that are relatively new to the market or companies where there are expectations for abnormal income or profit growth compared to the company’s history.

There are periods where the market may favour one style over another, so growth stocks may outperform value stocks at times, and at other times value may outperform growth. Many investment portfolios use a mix of different styles to ensure smoother and more consistent performance over time.

There are other portfolio managers that have themes on either certain parts of the world or certain sectors. For example some portfolio managers may believe that China will outperform the rest of the world and have more of an exposure to stocks that will benefit from this. Alternatively, a portfolio manager might think that the energy sector or the health sector might outperform the market and have more exposure to those sectors.

The investments that you ultimately hold need to reflect your current situation, appetite to risk and your future goals. As investment markets are quite complex and everybody is different, it is always a wise choice to discuss your approach to investing and the mix of investments in your portfolio with your financial adviser.