DIVERSIFYING ACROSS investment styles is fundamentally important for a balanced portfolio. Individual investment managers use differing styles (techniques) for analysing and researching the investments they will select for their clients.
It is imperative that you have an understanding of the various techniques to ensure that you have diversified your portfolio across a variety of alternative styles to ensure that you are not holding all of your eggs in “one style basket”.
Defining growth and value
One such style is known as “growth investment” and another as “value investment”.Growth investing is buying equities in companies that tend to grow substantially faster than others. In most cases, this involves buying young companies with high potential. The theory is that growth in earnings and/or revenues will directly translate into an increase in the stock price.
A value company is one that is relatively cheap compared to its earnings and book value, and compared to other stocks in its peer group. Value investors and fund managers look at a company’s financial outlook, its product health, its market position compared with competitors and use these factors to evaluate the stock price.They tend to have a longer outlook than more aggressive investors.
Though growth and value strategies run relatively close when considering long-term performance, some investors place more confidence in one style than the other. But too much confidence can hurt.
Growth and value equities rarely perform in tandem. Generally, value does better during bear markets. When the market is declining, value stocks hold up better because they are less expensive than the market as a whole across a variety of valuation metrics.
Growth stocks, usually more expensive and with more to lose based on those same measures, tend to trail in defensive markets. But when the bulls charge, growth stocks pull ahead spurred by increased investor optimism.
When one looks at data as to how growth and value equities performed in the past, it is easy to jump to the conclusion that predicting whether growth or value will lead, depending on the economic cycle, is simple. But counting on such timing rarely is a consistently successful strategy due to the well-documented unpredictability of global economies.
It is a natural tendency to extrapolate past results into future outcomes, but predicting what kind of market environment we are going to have is extremely difficult.
The late 1990s are a prime example of chasing performance…and being disappointed. Some investors did not warm up to growth stocks until the end of 1999 and start of 2000. They finally bought when those stocks peaked. It was too late and their portfolios suffered as a result.
Large and Small Company Stocks: defining caps
The “cap” in “large cap” and “small cap” stands for capitalisation, a measure used to classify a company’s size. Put simply, it refers to the value of a company, that is, the market value of its outstanding shares. The classification of companies into different caps helps investors gauge the growth versus risk potential. Historically, large caps have experienced slower growth with lower risk. Meanwhile small caps have experienced higher growth potential, but with higher risk.
Large cap – These companies have a market cap between http://www.0-http://00 billion (even larger companies are known as “mega cap”). Many well-known companies fall into this category. Typically, large cap stocks are considered to be relatively stable and secure. They are sometimes referred to as “blue chips”.
Mid cap –Ranging from http:// billion to http://www.0 billion, this group of companies is considered to be more volatile than the large cap companies. Growth stocks represent a significant portion of the mid caps. Some of the companies might not be industry leaders, but they are well on their way to becoming one.
Small cap – Typically new or relatively young companies, small caps have a market cap between www.00 million to http:// billion. Although their track records will not be as lengthy as that of the larger caps, small caps do present the possibility of greater capital appreciation – but at the cost of greater risk.
Over any period of several years, small cap and large cap stocks go sharply in and out of favour among investors. They rarely have both been extremely productive at the same time. Over a period of 36 years, we saw five dramatic reversals in the relative performance of small cap and big cap stocks. Investing exclusively at either end of the scale and ignoring the other end was not a good idea for the whole period. There is no predictable pattern of how long these trends last either.
Diversification as your safety net
The phrase about past performance not being an indication of future results is not just a legality, it is a fact of life. No asset class or style behaves in a consistent, predictable pattern, so it is very difficult for investors to make forecasts by looking backward.
A style-neutral, multi-manager approach helps to diversify your assets and spread risk. Rather than trying to decide when to invest in each style, this process diversifies portfolios by identifying and selecting both growth and value managers and also various capitalisation sizes. Picking skilful managers and maintaining a balanced portfolio can be more beneficial than trying to predict which style will forge ahead and when.
Asset allocation and diversification remain the keys in today’s market environment. Diversifying assets among capitalisation tiers and equity styles continues to make sense.
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By Bill Blevins, Financial Correspondent,Blevins Franks