There are three main investment styles: growth, value and quality. These terms mean different things to different investors.
However, growth companies can generally be defined as businesses that are projected to grow ahead of the rate of GDP growth. They tend to perform best when investors are prepared to have long-term time horizons and are feeling confident.
Typically, such stocks tend to do well as the investment cycle is drawing to a peak.
Examples of good growth-biased funds include Baillie Gifford Global High Alpha and Natixis US Equity Leaders.
Growth companies often have positive price momentum. There are few funds that focus solely on price momentum, although tracker funds are implicit momentum strategies since allocations rise in line with the growth in a company’s market capitalisation.
Value companies can usually be identified by either profits, sales or assets trading at below average market multiples.
There is plenty of empirical evidence to suggest that stocks priced cheaply in the market outperform over the long run.
However, such a journey can be bumpy and typically a proportion of the companies will either slowly shrivel and die or collapse more spectacularly.
Some shares held by value managers will include names that many managers either won’t invest in, don’t invest in or can’t invest in. Value companies often perform best in the immediate aftermath of a market trough. There are a number of good funds following this strategy such as Jupiter Special Situations, River and Mercantile UK Long Term Recovery and Schroder Recovery.
Quality companies tend to have stable revenues that are little affected by the economic cycle. Examples include business franchises that have wide moats, consumer staples such as tobacco, and branded goods firms such as Unilever. Often these businesses are highly cash generative and have solid balance sheets.
Growth rates are rarely eye catching but tend to be sustained over the cycle. As a result, returns can compound with powerful effect over time. Quality companies tend to outperform during market downturns and during periods when investors’ nerves become frayed.
More recently, such an approach has done well as bond yields have fallen. Funds with a strong quality bias include First State Global Listed Infrastructure and Fundsmith Equity.
Not mutually exclusive
It is important to recognise that these main style groupings are not mutually exclusive, as the diagram illustrates. It is quite possible for a share to have growth, quality and value characteristics although this would be fairly unusual.
Usually such situations occur when something awful has happened – whether specific to the company, such as a scandal or fraud, or the market as a whole is in turmoil. But for those investors with patience and the courage of their convictions, this can often be the most attractive moment to be buying stocks.
It is difficult to predict which style will work best in the current market but there are a few pointers that may help. For example, value strategies typically do well during economic recoveries. In contrast, when long-term interest rates are falling, they should provide a theoretical boost to longer-duration growth strategies. However, as much as anything, market sentiment seems to be the biggest driver.
It is quite possible for a share to have growth, quality and value characteristics although this would be fairly unusual
Value strategies have remained unloved for an extended period and the relative performance of many value funds has languished. By definition, value stocks are cheaper than the market, but the degree of cheapness is more than the historical average. (In contrast, value was relatively expensive in 2006/07).
On the metrics that we look at, however, growth and particularly quality growth stocks appear more expensive than usual. It would be courageous to focus a fund portfolio in this direction at this juncture.
Advisers need to be diligent in the way in which they construct their portfolios. Building portfolios based on performance tables can skew the portfolio’s style biases in an unhealthy manner. A change in trend in markets would threaten to leave such portfolios hopelessly trailing their objectives.
It is important for advisers to understand how the funds are managed when building portfolios.
Jason Broomer is head of investment at Square Mile Investment