Investment philosophies - only as good as their application
Every asset manager has an investment philosophy – a stated approach to investing. The philosophy, together with the discipline and rigour of the process used to apply the philosophy and the skill of the people applying it, will determine the success of the outcome.
To understand an investment philosophy, the first question is whether the asset manager is an active or passive investor. Active managers believe that markets are imperfect pricing mechanisms and that, if correctly identified, these imperfections create opportunities that can be exploited. Passive managers believe that markets make fewer errors and that share prices tend to reflect all available information and therefore cannot be predicted in any meaningful way, says Greg Fury, Chief Operating Officer of Allan Gray.
“Passive managers say it’s difficult to identify and take advantage of opportunities and the additional cost involved in trying to do so may more than offset the benefit,” says Fury.
Empirical evidence over long periods seems to show that the “passives” are, on average, right. However, this masks the fact that asset managers produce a wide range of returns and the most successful actively managed funds have outperformed the market substantially. “Investors who had the skill and confidence to choose these managers have been handsomely rewarded,” says Fury.
The type of returns the manager focuses on is another aspect of a philosophy. Some managers focus on ‘absolute returns’, which are returns that outperform inflation over time. Others focus on generating excellent ‘relative’ returns, or returns that outperform a benchmark such as the FTSE/JSE-ALSI Index.
The third aspect of investing used to describe philosophy is ‘style’, says Fury, which is the type of shares a manager invests in. The most common styles applied to equities are ‘value’ and ‘growth’.
In general, value investing is characterised by the search for stocks that trade at lower than average price to earnings (PE) and price to book value (P/NAV) multiples and higher than average dividend yields.
Growth investing is buying shares in companies that are expected to grow at a faster rate than the average company. Growth companies therefore often trade at PE and P/NAV multiples that are higher than the average and have lower than average dividend yields.
A third approach – fundamental or valuation-based investing - combines aspects of both value and growth investing.
Fury says that investment philosophies are only as good as their application. To judge the merit of a particular philosophy it’s important to assess how a manager behaves against it over a long period, through several market cycles.
“In selecting an asset manager investors need to understand the manager’s investment philosophy and then assess this against their long term performance track record,” Fury concludes.
