Markets fluctuate endlessly based on individual decisions derived from reason and emotion, so sticking with a particular style – known as “style investing” – can provide some measure of comfort amid the volatility. Some noted investors who have already made their fortunes aren’t afraid to admit they invest by style. In fact, the famous Warren Buffet openly considers himself a “value investor.” We’ll discuss the basics of style investing and why you might consider choosing one or more of these paths on your journey toward prosperity.
Instead of investing in specific securities, you can choose to rotate among more broad-based categories of assets such as: large cap stocks, growth stocks, value stocks, international markets, government bonds, venture capital or emerging markets. This advanced-level practice is referred to as style investing. The most common styles include Value investing, Momentum investing, Carry investing, and Defensive investing.
The three primary advantages of style investing are that:
· It simplifies decision-making and allows investors to process vast amounts of information efficiently. Breaking down your financial allocation to 10 asset styles, rather than thousands of listed securities, simplifies choice.
· The growth or value index helps investors benchmark the performance of their professional money managers. Choosing a style automatically allows for comparison among similar money managers.
· Style is at the heart of proper asset allocation and a key element of modern portfolio management.
Tips for Style Investing
To get the most out of style investing, a skillful manager will:
· Make sure your risks aren’t overly concentrated in one particular industry or country.
· Go beyond diversification to make the contributions across styles as balanced as possible to spread out the risk.
· Exercise patience to minimize excessive turnover and transactional costs, as well as style tracking errors.
· Target 10-12% portfolio volatility in the long run.
· Allow for short-term deviations in volatility when agreement across styles goes above or below expectation.
What is your investment style?
Style investing requires mastery of “the three dirty words in financing” — leveraging, short-selling, and derivatives – in order to maintain market neutrality, diversify risk, and increase returns. Putting together a portfolio of style premia requires careful decision-making, a risk-managing portfolio construction, and effective management. Ultimately, you may build your portfolio based on the following broad-based investment styles:
· Value – Buy cheaply-priced, undervalued assets and sell off your “expensive” assets.
Value investing is probably the best-known style, dating back nearly 40 years. A value style portfolio can be constructed by looking at the ratio of price relative to book value of a company (P/B), or the price relative to earnings (P/E). You’ll then sort a set of stocks by value, investing heavily in the long-term, high-value stocks and short-selling the high-priced, low-value stocks. Experienced managers understand that there are more in-depth ways of assessing risk. Examining earnings, cash flows, and sales (relative to price) produces a more robust portfolio.
· Momentum – Buy assets that recently outperformed peers and sell those that recently under performed.
Just as well-known and supported by evidence, Momentum investing looks at the persistence of performance over a period of time. You’ll look at the past 12 months of returns for your assets, going long on the out performers and short on the under performers. The portfolio will have little correlation to traditional markets when applied across a universe of assets, which is important in diversifying risk. We can look at stock factors like earnings momentum, changes in profit margins, and changes in analyst forecasts in building a robust portfolio.
· Carry – Buy high-yield assets and sell low-yield assets.
Macro-economists and currency market practitioners are most familiar with carry investing, where you’ll short-term borrow from lower yielding markets or assets and long-term lend in the higher yielding markets or assets. In currency markets, you may sort countries by three-month lending rates – borrowing from markets with the lowest rates and lending to markets with the highest rates over the decades. Profitability can be increased and risks mitigated by investing beyond currency markets into other arenas like equities, fixed income, and commodity futures.
· Defensive – Buy low-risk, high-quality assets and sell high-risk, low-quality assets.
Defensive investing has been around since the 1970s, but it’s surged in recent years as investors look for ways to get bigger returns. In stocks, you can sort by forecasted betas, going long on low-beta stocks and short on high-beta stocks to maintain market neutrality and manage risk across the portfolio. Looking beyond beta, you can measure quality by favoring assets with high profitability, low leverage, and stable earnings among stocks or short-duration assets in fixed income markets.
The 6th Avenue Team at Ingalls & Snyder, LLC is adept at all aspects of style investing, whether you want targeted guidance or full hands-on portfolio management from us. We can help you adapt your current investing style and strategy to your short and long-term financial goals, helping you navigate life’s biggest transitions, be it divorce, the kids going to college, starting your own business, receiving inheritance, or retirement. Contact an investment advisor representative at our New York City office to learn more.
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