By Daniel Archibald | CFA
Investing in equities has proven to be worthwhile endeavour over the last century, despite the occasional cliff dive. And in order to give those without the skills or time to research which stocks to be purchasing, fund managers have stepped into the responsibility of taking care of much of the trillions of dollars set aside for share investments. But not all fund managers think the same way, and not all invest how you might think. In this month's article, we take a look at the different styles of equity fund managers available to be utilised by investors.
Non-Style Based Managers
Index
An equity "index" fund manager will simply look to mimic the returns of a chosen index, usually the main established equity indices such as the S&P500 (US), ASX S&P200 (Australia), Eurostoxx50 (Europe). This means that this style of fund manager does not spend time researching individual stocks, but just looks to copy the index returns. They can do this through perfect replication (i.e. owning the exact same portion of shares as the index - easy for indices containing a smaller number of securities), or through some sort of sampling optimisation (i.e. owning securities that represent a number of index constituents, such as owning just CBA and ANZ in stead of owning all of the four major banks).
Enhanced Index
This is similar to an index fund, except that they may employ a few extra tricks in order to gain returns to beat the index. These added techniques still do not generally involve researching individual stocks, but are more focussed on small arbitrage opportunities (usually transactional) in order to eke out a greater performance (e.g. buying a stock that is anticipated to join the index well in advance, thus enjoying the added price lift that usually occurs once the stock is added to the index).
Style Based Managers
Value
A "value" equity fund manager generally looks to invest in stocks that look "cheap" from a valuation point of view. This may be based on its current price-to-earnings (P/E) or price-to-book (P/B), with a lower ratio compared to peers signifying potential value, or may be based on quality of earnings or dividend yield. This type of style has historically produced superior returns on a frequent basis, which is logical from a "buy low, sell high" point of view.
Growth
This type of a manager is primarily interested in companies that are set for superior growth in sales and profits. The company may not have significant current earnings and may even be trading at a loss. But equities of interest to a "growth" manager will be in industries of strong technological advancement or in companies sitting on large potential resources (e.g. biotechnology, junior miner). This type of fund tends to do well when economic conditions are strong.
Mixed - GARP, Neutral, Core
A "GARP" (growth at a reasonable price) style manager looks to invest in companies with high growth potential, but will also filter out companies that do not look attractive from a value point of view. This can be seen as somewhat of a mix between "value" and "growth". "Neutral" or "core" managers tend to not focus on any particular metric (value, quality, growth, momentum), but will invest in both "value" or "growth" stocks.
Thematic
This type of fund manager will not necessarily focus on the individual security characteristics, but will pay more attention to the overall state of economy and industry conditions. Whereas the above 3 styles mainly pick stocks from a stock specific fundamentals point of view ("bottom-up"), a thematic style manager will first look at what sectors of the economy are expected to out perform and then pick stocks in those sectors or industries ("top-down").
Long/Short and Market Neutral
A "long/short" equity manager has the added option of also short selling stocks (i.e. sell stocks that they don't already own). This may be in order to take advantage of overpriced stocks or to reduce the overall market exposure of a portfolio. Most of these funds still hold a net exposure to the market of 100% and do this by using proceeds from short sales to buy extra stocks. "Market neutral" equity managers, however, hold no net exposure to the market. They do this by buying the same amount of shares as the short sell, meaning that if you give them $1 to invest, they will technically keep that $1 in cash, and short sell $1 in shares, and use that $1 to buy some other share. Commonly, "market neutral" managers will look to buy one stock in an industry and short sell a stock in the same industry (e.g. buy NAB, sell ANZ), looking to gain on the difference in price movements between the 2 stocks.
Dividing the Market
Some funds will invest only in their mandated sub-sector, whether it be related to the size of the company (e.g. "small-cap" fund) or to its industry (e.g. resources fund). The manager can still utilise the above styles, but will do so only within this smaller portion of the equity universe.
Yet, other styles of equity fund managers exist, such as those that use derivatives (e.g. "buy/write" managers) or those that manage net exposures with either cash, short sales or derivatives (e.g. reduce market exposures in times of market stress or crisis). Though it is not possible to categorically say which style will perform best at any particular time, it is still important to understand the style that your chosen fund managers are utilising to ensure that you are invested in line with your desired investment strategy and overall appetite for risk.