If there’s one thing investors have been reminded of in 2020, it is that investing is certainly not a linear journey. There will be ups and downs and sharp swings in the market’s direction. This movement in financial markets and how drastically they could swing is what is referred to as volatility. The good news is that it is ‘normal’ for investments to come with some risk and market volatility, without taking on risk it would not be possible to reach the returns required to meet one’s investment goals. The not-so-good news is that Investors do not always understand just how turbulent the volatility can get from time to time, which leads to feelings of anxiety.
Although the turbulence that comes with investing cannot be eliminated, it can be managed. Riccardo Fontanella, Head of Technical Marketing at Alexander Forbes Investments, explains that the world of investing offers up a host of investable opportunity sets across asset classes and styles of money management, each with their own characteristics that determine their responsiveness to the motions of financial markets over time. “Managing savings and investments in a way that seeks to spread investments across this investable spectrum to deliver less volatility without reducing return potential is key,” says Fontanella.
While many investors may be familiar with the types of investments their savings and investments are allocated to (for example, equities, bonds and property), very few really understand the underlying style, or styles of money management that dictate how and why their savings and investments are ultimately invested the way they are. “An investment style refers to the process that dictates how an asset manager manages money on behalf of investors, including how they would choose investments within their portfolio,” explains Fontanella. Investments styles are broadly guided by an investment philosophy – standards or beliefs – that project an asset manager’s world view of investing and how it goes about its investment activities. Fontanella says that because all asset managers are unique and have different views, with their biggest differentiator being their investment philosophy, it only stands to reason that a large number of money management styles exist.
To help make sense of the investment style universe, Fontanella discusses the main types of investment styles or investment strategies (although not exhaustive) most commonly researched within the South African asset management industry.
|Value||The emphasis is on shares of companies that are undervalued, meaning that the market value is less than the calculated intrinsic or ‘real’ value as calculated by the asset manager.|
|Momentum||Looks for positive market trends (for example price or earnings) and aims to increase exposure to the shares of companies benefiting as a result of such trends.|
|Growth||Bias towards shares of companies that have high expected growth, high earning and profit margins.|
|Quality||Bias towards shares of companies that display good financial criteria such as strong balance sheets, capable management and sustainable cash flows and earnings.|
|Size||Focuses on market capitalisation (the market value of a publicly traded company’s shares – it is equal to the share price multiplied by the number of shares outstanding). Three broad categories differentiate a company based on its market capitalisation, namely small-, mid- or large- capitalisation.|
|Top-down||This means closely observing and analysing macroeconomic factors as a basis for making investment decisions. Key to this approach is
understanding the impact of different macroeconomic factors on various types of investments.
|Bottom-up||Bottom-up investing begins its research and analysis at a company level to assess key investment attributes that ultimately drive investment decisions. Bottom-up investing may also include macroeconomic to supplement investment decisions.|
So why is this important? Fontanella explains that different styles of money management excel at different times as financial markets move between cycles. This means that asset managers perform differently to one another at various stages of the market cycle, and that no single asset manager can consistently outperform at all stages of the market cycle. “This makes a strong argument for maintaining diversified exposure across various investment styles to weather short-term market volatility, while also being positioned to deliver favourable risk-adjusted outcomes in the long term,” says Fontanella.
Think of it as not putting all your bets on a single horse, or investment style in this case, Fontanella explains. “It exposes you to higher risks because if that horse does not win, you can lose all or a portion of your money and potentially have no other investments to profit from.” This is a concept that holds true in the investment world, says Fontanella. “What you want is a blend of complementary investment styles so that the poor performance associated with one asset manager’s style can be compensated by the good performance of other asset manager styles, therefore keeping the risk of drastic changes in your return at a minimum.” This can help protect the fortunes of your investment outcomes from being dominated by the investment style or investment allocation decisions of a single asset manager, but it does not guarantee that investors’ returns will never be negative. The extent to which an investment participates in the market falls is, however, expected to be more muted given this added layer of risk management.
Having a good sense of which styles of money management ‘work’, meaning those that complement each over time, can give a manager of managers such as ourselves the advantage of knowing how to skilfully blend a mix of complementary asset managers within one multi-managed portfolio solution. “This can create compelling value for investors by generating competitive returns through various market and economic environments, and improving the likelihood of achieving their investment goals with as little stress and anxiety as possible,” concludes Fontanella.