It has started already.
The market has tanked and all the experts have started telling us how we might
go about finding the shares that will be the biggest winners over the next 12
While all share market fund managers and investment professionals have their own
style of investing, they generally fall into two main groups: those who are
looking to pick investments or asset classes that grow in value, and those who
are looking for assets that give superior returns to say bonds or cash. It helps
if we (as investors) have an idea of how the different styles will affect growth
and returns. It also helps if we understand what limits and constraints act on
certain styles of investing and how much scope fund managers have to avoid them.
Regardless of the different style used, all fund managers have the same goal: to
get good returns. Why? Because funds management is just like all good commercial
businesses: achieve better returns for your investors than your competitors and
more people will invest with you, the business will grow and you'll make more
Let's explain the different styles
Value investing or investing in a value fund
As the name implies, value investing means buying or investing in assets that
The measures used to determine if shares are undervalued may vary but they
generally involve identifying shares that are trading at low Price to Earnings
(PE) multiples compared to similar companies, or are underpriced for numerous
other reasons. They could be trading at a discount to their asset value.
This style of investing is credited to Benjamin Graham. Graham has written many
books on how and where to 'find value' but his most famous student, Warren
Buffet, has always described the investment style as "finding an outstanding
company at a sensible price." I think ANZ is a good example. The share price
today is almost 50% less than it was 6 months ago. Where do you think it will be
in 18 months time? Do you think it will do better than the cash rate of around
8%? In other words if the share price of ANZ is now $15.50 do you think it will
be worth more than $16.70 in 12 months (or 8%)? I suspect it may be more than
that by October.
Growth investing or investing in a growth fund
Again as the term implies growth investing is a style that seeks to pick an
asset that has greater potential for future growth and earnings than it
currently shows. This style of investing looks for shares that are expected to
grow at an above average rate and give good capital gains over time, with less
regard to earnings (as the share grows in value so will the earnings). This
anticipated growth could be because of its technology, processes or another
advantage over its competitor.
These 2 styles are often seen as opposed but the hybrid of value and growth
investing is what's known as GARP (Growth at Reasonable Price) or when cheap
meets good growth potential. Is it now sounding a little contrived? Well it is.
Yes they both want the same, the price of the share to increase. It's just the
methodology that's used to come to the conclusion to buy.
Interestingly, history has shown that value funds outperform growth funds over
Contrarian investing or not following the herd
This is related to doing the opposite of the crowd. The idea behind contrarian
investing is if there is wide spread pessimism, as there is now, that pessimism
can lead to shares being driven down much further than is justified which
creates buying opportunities. Conversely some shares are often overhyped which
can lead prices to be inflated well above their true value. In this case the
contrarian would be selling. This can apply to individual shares or to whole
sectors, e.g. media stocks or mining stocks. Which one would you see as a better
buying opportunity at the moment?
Momentum investing or buying high and selling higher
This is as it sounds, using market momentum to invest. Momentum managers look
for trends in shares movements. Are they tending higher or lower? If a share has
been increasing over a 3 month period then it tends to continue, and a momentum
manager will buy. Conversely if a share has been falling over the same period a
momentum manager will tend to sell.
What about index funds?
These funds buy shares that make up the index. Before we look at some of the
pitfalls let's examine what the S&P/ASX200 actually is.
The S&P/ASX200 was launched in April 2000 and coincided with Standard and Poor's
taking over the index business that was run by the Australian Stock Exchange.
The index is made up of the top 200 companies in Australia (just as the S&P 500
of the US is the top 500 companies in the US).
In Australia this index is made up of 200 companies with over $200 billion
combined capital value and represents around 80% of the Australian equity
So if you are invested in an index fund you are simply buying the shares that
make up the index. So if BHP represents 14% of the index then 14% of your money
is in BHP. The same applies if Westpac is 3.5% of the market and so on. So it's
very representative of the Australian stockmarket as a whole. Now fund managers
measure their performance as how well they do above the index. So if the whole
index performs at 12% for the year and your actively managed fund does well and
achieves 17% then you have outperformed the index by 5%. Simple!
Yes it is but what is extraordinary here is we all know that all shares can't
all be performing at the same time, so not all 200 companies in the ASX/S&P 200
will be going up in unison. Different economic conditions and cycles clearly
favour certain industries. For example, mining shares may be going gangbusters
while financials and media stocks are underperforming terribly. But if you are
the fund manager of an index fund you really have no choice but to invest in
them all, as long as they are in the top 200. If a share does badly it actually
reduces its percentage of the index which means as a fund manger you would have
to sell some of the shares. This is called reweighting and tends to force the
price down further.
Let's take BHP as an example: if its price goes up and it now represents 14.5%
of the index rather than 14% the fund manager must buy more BHP to match the
percentage. This is why even though all the research and economic data may tell
us not to buy a share, if you're in an index fund you own that dog whatever it
may be. You are over diversified and unless the rising tide floats all boats
index funds are not going to be the top performers.
This is why I don't like index funds. Little skill and research is needed. If a
good fund manager and his or her research team can't cherry pick the stocks that
are going to do well and those that aren't, considering all the info at their
finger tips, then what are they doing? Good fund managers should always be able
to outperform the index or you're perfectly right to ask what value they're
What are the other indices?
Other indices on the ASX include the S&P/ASX300, the 100, 50, 20, the MidCap 50,
and the All Australian 50. All these indices form part of the Australian stock
market, obviously with some overlap. Finally we have the All Ordinaries index
which is the top 500 companies listed on the exchange.
So where does all this leave us?
In summary all fund managers are trying to buy shares that will grow and
increase in value over time. They use different techniques to try and identify
the shares that will give their investors superior returns over time so that
they stay invested. If you invest via an index fund I guarantee you will end up
holding shares you wouldn't choose to buy yourself so go for a more active
investment style and invest with a fund manager who is out there looking for the
Don't invest in index funds!