Stock selection for individual investors can be a daunting task. Choosing securities from the global marketplace, analyzing, evaluating, purchasing and tracking performance of those securities within a diversified portfolio is not something most individual non-professional investors are able or willing to do. Instead, investors can make portfolio allocation decisions by choosing among broad categories of securities, such as "large-cap", "growth", "international" or "emerging markets". This approach to investing - looking at the underlying characteristics common to certain types of investments - is termed style investing.
The popularity of style investing increased considerably for institutional investors during the 1980s as the pension consulting community encouraged clients to categorize equity styles during the asset allocation process. Both institutional and individual investors found that categorizing stocks by style simplifies investor choices and allows them to process information about stocks within a category more easily and more efficiently. Allocating savings across a limited number of investment styles is a far easier and much less intimidating task than choosing among thousands of investment options available throughout the world.
By classifying assets according to a specific style, investors are also better able to evaluate the performance of professional money managers. In other words, all the money mangers handling emerging growth stock funds can be ranked by performance in that particular category. In fact, money managers are generally evaluated not in terms of absolute performance but relative to a performance benchmark for their style of investing.
Over the past decade, a new set of sub-styles, in addition to the usual styles of value and growth, has been accepted by the investment community. These are: deep and relative value and disciplined and aggressive growth.
Value style managers look for stocks that are incorrectly priced given the issuer's exiting assets and earnings. They employ traditional valuation measures that equate a stock's price to the company's intrinsic value. Value companies tend to have relatively low price/earnings ratios, pay higher dividends and have historically more stable stock prices. The value manager's basic assumption is that the issuer's worth will, at some point, be revalued and thereby generate gains for the money manager. There are several reasons that a stock might be undervalued: the company may be so small that the stock is thinly traded and doesn't attract much interest; the company is operating in an unpopular industry; the corporate structure is complicated, making analysis difficult or the stock price may not have fully reacted to positive new developments. Value stocks are typically found in slower-growing sectors of the economy like finance and basic industry but there are bargains to be found even in "growth" sectors such as technology.
During the 1990s, Standard & Poor's identified three specific sub-styles: deep value, relative value and new value.
- Deep Value style uses the traditional Graham and Dodd approach whereby managers buy the cheapest stocks and hold them for long periods in anticipation of a market upswing.
- Relative Value money managers seek out stocks that are under-appreciated relative to the market, their peer group, and the company's earnings potential. Relative value stocks should also feature some sort of channel (such as a patent or pending FDA approval) that has the potential to unlock the stock's real value. A typical holding period is three to five years. Unlike traditional value managers, relative value managers pursue opportunities across all economic sectors and may not concentrate on the usual "value sectors".
- New value managers choose their investments from all securities categories, seeking any stock that holds prospect for significant appreciation.
Growth style managers typically focus on an issuer's future earnings potential. They try to identify stocks offering the potential for growing earnings at above-average rates. Where value managers look at current earnings and assets, growth managers look to the issuer's future earnings power. Growth is generally associated with greater upside potential relative to style investing and, of course, it has concomitant greater downside risk.
- Traditional growth style investing has also spawned a few sub styles, specifically, disciplined growth or growth-at-a reasonable-price (GARP), and aggressive, or momentum, growth.
- Disciplined growth style managers concentrate on companies that they believe can grow their earnings at a rate higher than the market average and that are selling for an appropriate price.
- Aggressive growth styles tend not to rely on traditional valuation methods or fundamental analysis. They rely on technical analysis.
Look at a particular industry such as transportation. Because the holdings of this type of fund are in the same industry, there is an inherent lack of diversification associated with these funds. These funds tend to increase substantially in price when there is an increased demand for the product or service offering provided by the businesses in which the funds invest. On the other hand, if there is a downturn in the specific sector in which a sector fund invests, the fund will face heavy losses due to the lack of diversification in its holdings.
Tends to track the index it follows by purchasing the same weights and types of securities in that index, such as an S&P fund. Investing in an index fund is a form of passive investing. The primary advantage to such a strategy is the lower management expense ratio on an index fund. Also, a majority of mutual funds fail to beat broad indexes such as the S&P 500.
If you can't beat the market, why not join it? We go over your options in the following article: The Lowdown On Index Funds.
A global strategist builds a diversified portfolio of securities from any country throughout the globe (Not to be confused with an international strategy, which may include securities from every other country except the fund's home country.) Global money managers may further concentrate on a particular style or sector or they may choose to allocate investment capital in the same weightings as world market capitalization weights.
Stable Value Strategy
The stable value investment style is a conservative fixed income investment strategy. A stable value investment manager seeks short-term fixed income securities and guaranteed investment contracts issued by insurance companies. These funds are attractive to investors who want high current income and protection from price volatility caused by movements in interest rates.
Dollar-cost averaging is a straightforward, traditional investing methodology. Dollar-cost averaging is implemented when an investor commits to investing a fixed dollar amount on a regular basis, usually monthly purchase of shares in a mutual fund. When the fund's price declines, the investor can buy a greater number of shares for the fixed investment amount, and a lesser number when the share price is moves up. This strategy results in lowering the average cost slightly, assuming the fund fluctuates up and down.
This is a strategy in which an investor adjusts the amount invested, up or down, to meet a prescribed target. An example should clarify: Suppose you are going to invest $200 per month in a mutual fund. At the end of the first month, thanks to a decline in the fund's value, your initial $200 investment has declined to $190. In this case, you would contribute $210 the following month, bringing the value to $400 (2*$200). Similarly, if the fund is worth $430 at the end of the second month, you only put in $170 to bring it up to the $600 target. What happens is that compared to dollar cost averaging, you put in more when prices are down, and less when prices are up.
Exchange Traded Funds (ETFs)
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