Diversification has been clearly established as an effective tool for managing the risks of investment. A fully diversified portfolio of managed funds can be diversified at three levels:
• over investment sectors - cash, fixed interest, property and shares
• domestically and internationally
• over different manager investment styles
It is the last of these three that this article considers.
Professional managers apply a particular investment style to managing money. These approaches reflect different methods of selecting investments and deciding when is an appropriate time to buy and sell.
Depending on the approach utilised managers will produce varying results over shorter periods depending on the prevailing economic conditions.
Combining managers with different styles is recognised as a valid diversification step. The intention is to reduce the variability or volatility of returns in a portfolio while maximising the return earned for the risk being taken.
The failure of a manager to perform in particular economic conditions does not make him a bad manager. It could just be that his particular style is not suited to current conditions. No one style has shown itself to be successful in all economic conditions. Neither is it possible to successfully time in and out of styles.
In managing shares, as an example, a number of different styles can be identified.
The top-down approach looks at local and international factors, followed by selection of countries, regions or industries followed by selection of the individual investments. An investment opportunity in a sector will be forgone in favour of the wider top-down decision which might suggest withdrawing from the sector altogether.
A bottom-up process starts with the investigation and selection of particular investments.
A manager may use a passive approach in closely tracking an index such as the NZX50 or he might use an active approach which might see significant deviation from market weightings in particular shares in an effort to outperform the market.
In analysing investments some managers focus on growth prospects while others focus on the value of a share in comparison to its current market price.
There are clearly a number of different styles or approaches that can be utilised. Combining good managers, who have different styles, provides benefits for your portfolio.
