Whats The Investing Style Of Your Fund Manager?

When it comes to investing in mutual funds, it is always advisable not to just look at the returns, but also the portfolio and, more importantly, a fund manager’s style of investing. As explained in this article, there are two styles of investing – value and growth.



Behavioural bias is one of the hurdles of becoming a successful investor. Investors burdened with such bias typically make poor investment decisions. Many a time their investments fetch negative real rate of returns. Real rate of returns turns negative when the investment avenue generates returns lower than that of the prevailing rate of inflation. When it comes to investing in mutual funds, there are two major behavioural biases that investors carry. One is the ‘recency’ (a time immediately before the present) bias that leads investors to take decisions on recently generated returns.

The other is the ‘rating’ bias which makes investors look only at a mutual fund’s star ratings before investing. Though we are not against star ratings, these can be used as a first screen. Further, in our previous issue we have discussed how ranking is better than star ratings. But apart from returns and ratings, there are various things that a mutual fund investor must check before making any investment decisions. This includes the risk involved by investing in a particular fund or an asset class with respect to individual risk appetite. In addition, he should also look at the portfolio and the fund manager’s experience.

In fact, it is very important to check out the fund manager’s style of investing. Though the inherent portfolio decides the returns of mutual funds, the fund manager’s philosophy of investing defines what would move in and out of the portfolio. In this article we are going to look at the various different styles of investing and how that impacts a mutual fund investor. There are basically two styles of investing: growth style and value style. And each style has its own traits. In fact, there are some funds that incorporate both the styles, popularly known as the blend style.

Being two different styles of investing they have their own set of pros and cons. That said, both of them seek to have a common goal – increasing the investor’s wealth. The investment style of a fund manager makes him or her maintain a style consistency irrespective of the market cycle. And both styles work differently in different phases of the market cycle. There will be a time when the growth style will work whereas the value style might lag behind or the other way around. Therefore, as an investor you need to have an all-weather portfolio by having a right mix of these unique investment styles.

Growth Investing

Fund managers following the growth investing style typically focus on the earnings’ growth capacity of the stocks. Here the idea is to seek companies that have grown consistently in the past and would potentially to do so going forward as well. Moreover, apart from earnings, fund managers also look at key financial metrics such as cash flows and revenues. Typically, growth stocks possess quality earnings. Fund managers following the growth investing style usually expect selected stocks to record earnings’ growth higher than that of industry average and at a sensible rate. Further, valuation ratios such as price to equity (PE) and price to book (PB) are typically higher for such stocks.

Value Investing

Value investing is one of the oldest styles in investing. When it comes to this particular style, there are different schools of thought. When a fund manager adopts value investing, he or she essentially looks to buy a stock that is cheaper than its intrinsic value. Price to equity, price to book, price to cash flow and price to sales are some of the traditional value screeners. Moreover, value stocks usually bear a higher dividend yield with respect to the market. Apart from these screeners, fund managers also analyse a number of other factors while filtering a value stock.

For instance, presently a particular stock might be valued attractively but might not have a good future prospect whereas there might be a stock that is facing selling pressure due to some negative news but its fundamentals are intact. Therefore, fund managers focusing on value investing style try to seek stocks that are currently facing headwinds or are out of favour but with sound fundamentals. Mostly, fund managers use discounted cash flow (DCF) analysis in order to ascertain whether the stock is worth buying.

Choosing the Right Style

As mentioned earlier, both growth and value styles of investing tend to run in cycles. Companies having the potential to give higher returns and those that have recorded better-thanaverage gains are classified as growth stocks. Simply put, growth stocks have a healthy earning record and are generally expected to continue the same in the future as well. Though investors get attracted to its future growth prospects, the risk of a sudden drop in its price due to negative earnings or bad news can’t be ignored. Value investing, on the other hand, works on two primary concepts – undervaluation and overvaluation. And the idea behind value investing is to simply buy a stock when it is undervalued and sell when it moves above its intrinsic value.

Value investing is considered to carry lesser risks with respect to the market. However, the question still persists as to which style is better? And which is likely to give higher returns over the long term? To begin with, one needs to understand that neither approach is guaranteed to provide appreciation in stock value as both of them carry investment risks. Given below are the average one-year, three-year and five-year trailing returns of growth, value and blend investing.

As can be seen, in each period the growth style has proved to be better than the value style. In fact, even a blend investing style has performed better than value investing. Therefore, though value investing seems to be less risky, it is less rewarding as well. A very long-term investment horizon is required for value investing.

Conclusion
When it comes to investing in mutual funds, it is always advisable not to just look at the returns, but also the portfolio and, more importantly, a fund manager’s style of investing. As explained above, there are two styles of investing – value and growth. Each has its own characteristics. However, when it comes to returns, it does seem that the growth style provides better returns. However, investors need to bear in mind that they need to look at their financial goals before choosing funds. If their financial goal is spread over 10-15 years, investment in funds following the value style makes sense. Else, it is prudent to either invest in funds with growth or blend style. Further, your psychology matters too. If you are a person who has the patience to see paint dry or grass grow, then you can very well invest in funds following the value style of investment.