Is It a Matter of Style?

There are thousands of mutual funds to pick from. Each has different managers, different mandates and different styles. These styles have become increasingly sophisticated, complex and blurred, all at the same time.

Frankly, all this talk about management style confuses me and I'm supposed to be the expert. At first glance, the distinction between value and growth seems to be quite simple. Value managers place emphasis on CHEAP stocks while growth managers place emphasis on GROWING stocks.

According to the S&P Barra index, the sole criteria in determining the difference between value and growth is the book value of a common equity divided by the market capitalization of a firm: book-to-price ratio.

Take a look at the performance of value vs. growth according to the S&P Barra indices:

S&P BARRA Indicies (Oct 31, 2000)
1 mo 3 mo 1 yr YTD 3 yr 5 yr 10 yr
S&P Barra Growth -2.6 -7.02 2.07 -8.79 21.0 24.1 20.5
S&P Barra Value 1.9 8.67 9.68 8.81 13.4 18.7 17.9

It is very clear in this chart that over the last 3, 5 and 10 years, growth has outperformed value. However, in the last year, the performance edge has shifted to value investments. Is this the start of a trend? Or, will growth come back to dominance? Unfortunately, this chart does not tell us whether value or growth will outperform in the future. So which is better? To help us with that question, we should look at the difference between value and growth.

VALUE APPROACH

Value managers' first priority is to find cheap investments. Often that can lead them into investments and markets early, sometimes before the bottom of a cycle. Value investors have been referred to as contrarians and otherwise known as boring, patient investors.

On the sell side, they will often exit after substantial profits have been made and the intrinsic value of the investment is reached. Often, Value managers will sell before the investment reaches the top of a cycle.

GROWTH APPROACH

Growth managers do not always buy at the bottom. Rather, their first priority is to look for clear signs of growth or upward momentum. Growth managers tend to profit and shine later in the cycle. Their sell discipline also tends to cause them to sell later in the cycle when there are significant signs of negative momentum.

For the last 24 months, growth and momentum managers have far exceeded the returns of value managers. Growth sectors like technology drove these values higher and higher.

There's more to it than Value and Growth

While the industry tends to look at the two major categories of value and growth, I think there are very few managers who are truly disciplined to be one or the other. As a result, many new hybrids and style classifications have emerged like Momentum, Relative Value, Sector Rotators, Top-Down, Bottom-up, GARP, etc.

Understanding the different types of styles is only half the battle. The problem is that it is very difficult to know how a fund or manager is truly classified. In my ongoing quest to understand all of these classifications, I have found there is very little consistency in how managers and funds are classified by their management style. Some critics attribute this problem to style drift where managers change their style to accommodate certain stocks.

One example is that, by definition, a technology stock should not be part of a Value Fund. However, there are many value funds with technology stocks because you had to own technology in the last couple of years to make money. Hence the development of a new classification called relative value.

Unfortunately, the area of style classification is becoming a science of its own because of the complexity and confusion.

The morale of the story – A Fundamental Argument

Knowing which style will be in favour in the future is a futile strategy because you cannot time the markets. Rather, it is important to take the time to understand the style or discipline of a particular fund or manger. Worry less about how it is classified, as there is too much inconsistency. Worry more about understanding the buy and sell strategy of good managers. The best managers can tell you exactly what their investment disciplines are and why they work. If you do not have the time, expertise, resources to do this yourself, then get the help of a financial advisor who can help you attain this information.

Finally, diversification is a principle of investing that will never sleep. Invest in different styles of money management. This balance will help you to avoid sleepless nights. Just like you will balance stocks, bonds and cash; and geographic markets around the world, you should balance value and growth and other management styles.

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace. For more information you can follow him on Twitter @JimYih or visit his other websites JimYih.com and Clearpoint Benefit Solutions.

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