What is Style Analysis?
Style analysis is the process of determining what type of investment behavior an investor or money manager employs when making investment decisions. Virtually all investors subscribe to a form of investment philosophy, and a prudent analysis of a money manager's style needs to be performed before an investor can determine whether the manager will be a good fit for his or her personal investment goals and preferences.
Understanding Style Analysis
There is virtually an unlimited number of investment styles; however, some of the most common types of investment styles are categorized as growth investing, value investing and active trading. Some money managers change their investment styles over time, opting to go with one approach while it is working well and then switching to another when the old approach seems to be losing its luster.
- Style analysis simply means identifying a money manager's overall investment philosophy.
- There are many investment styles and variations and combinations of those styles, but some of the most common schools are growth investing, value investing and active trading.
- An investor will probably be more satisfied with a money manager that matches his or her style, but there is a diversification advantage to putting some funds with money managers who have a different style from your personal one.
Growth Investing Style
Growth investing is a style and strategy that is focused on growing capital. Growth investors typically invest in stocks or companies whose earnings are expected to grow at an above-average rate compared to its industry or the overall market. These types of stocks carry a lot of risk because shareholders rely solely on the company's success to generate returns on their investment. If the company's growth is unexpectedly slow, shareholders may end up facing a drop in share prices. Growth investing style is considered to be one of the more aggressive investment styles.
Value Investing Style
Value investors often seek out stocks that tend to trade at a lower price relative to their fundamentals and are considered undervalued as a result. Value stocks are often identified as having traits such as a low price-to-earnings ratio or a high dividend yield. Value investors believe the market overreacts to news, whether good or bad, resulting in price movements that don't match up with a company's long-term fundamentals. Value investment style lends itself to a buy and hold approach with a lower portfolio turnover, which can also save money in terms of fees. Value investing is known for its potential to generate excellent returns, however the style is able to accomplish this because investors typically hold positions between two to three years on average. This window of time brings significant price risk and opportunity cost, so investors using this style need to be patient and aware of such risks.
Active Trading Style
Active trading, also known as day trading or swing trading, is considered a highly-speculative trading style. A day trader buys and sells securities with the intent of holding them for a short duration, often times no longer than a day. Active traders look to take advantage of short-term price movements in highly-liquid markets like stocks, options and foreign exchange. Most active traders use leverage (debt or borrowed capital) in an attempt to enhance the potential returns of their positions. A margin account allows you to borrow money from a broker for a fixed interest rate to purchase securities with the expectation of receiving high levels of returns.
Using Style Analysis to Select a Money Manager
Doing style analysis is relatively straightforward as most money managers explicitly tell investors what they practice. However, it is always worth looking at the money manager's track record in recent years to ensure that they are practicing what they preach. For example, seeing a value fund with a large turnover would suggest that the money manager is not as committed to his or her value picks as you'd expect. Generally investors should use style analysis to find a money manager that fits their risk tolerance. That said, there is an argument for putting some funds with managers whose style is different from your personal style as they will likely diversify your holdings in a way that is beneficial to your overall portfolio.