CAMRADATA, a leading provider of data and analysis for institutional investors has published a new white paper Does style matter? which examines different investing styles. The content was written following a roundtable discussion hosted by CAMRADATA with an expert panel of investment managers, pension consultants and asset managers.
The white paper analyses the various investment styles managers employ. It focuses on the fact style exposures are key drivers of portfolio returns because different investment styles can outperform (or underperform) for prolonged periods of time, so it pays to understand the content of a style box and how it changes over time.
Sean Thompson, Managing Director, CAMRADATA said, “Understanding and classifying styles helps investors dissect the drivers of fund performance more clearly, respond more intelligently and avoid knee-jerk reactions to the market’s changing style preferences.
“Even as a database provider, a unified fund classification framework also helps overcome the problem of inconsistencies among different fund managers in how they label their funds. Our white paper looks at key styles and is essential reading for any investor.”
Key findings from the White Paper
Historically, the development of investment styles sprang from two sources – the index providers, notably Russell, who wanted to better attribute manager performance, and academics such as Barr Rosenberg and Ken French that attempted to construct pure factor returns.
Smart beta and factor indices are the confluence of those two sources in today’s investment world. The mechanistic nature of factor indices, however, highlights the limits of style in investing.
Nick Samuels, head of equity manager research at pension fund consultancy, Redington made the point that a Quality index is a contradiction in terms. Nick said, “There are only a handful of Quality stocks in the world. Creating a systematic index requires diversification but that only waters down the effect of the real Quality stocks.”
In addition to any mechanistic analysis, the panel agreed there needs to be subtler understanding of the differences between stocks and greater work on the prospects for each company. After all, some stocks can veer from ‘Value’ to ‘Growth’ through time.
John William Olsen, portfolio manager of M&G’s Global Select Fund, said that as an active investor he believes that style categories can be “comfort blankets” for clients to give them a false sense of assurance they “know your style”.
Mr Olsen worries that this could result in the manager worrying more about the “branding of stocks” than the actual soundness of investments. He provided an example of the paradox of style. He said, “If you are a contrarian investor, you may well score low on momentum. Contrarians go against market sentiment. I don’t mind having momentum in the fund, but it’s not something we aim for. We want the negative momentum when we invest to turn into positive momentum. You have to be careful with style analysis because it is just a snapshot in time.”
The experts also discussed turnaround successes, which are attractive to many managers. Laurence Bensafi, portfolio manager of RBC GAM’s Emerging Markets Value strategy, is a big fan of turnaround opportunities.
But how do the experts pick turnaround winners rather than losers?
RBC GAM has a scorecard of 27 questions about governance to ensure its selections work. Failure on any of the questions will end MsBensafi’s interest.
The spotlight turned to the investment consultants who all affirmed they use style in analysing managers’ performance.
Martin White, managing director at investment firm, Cambridge Associates, said its research team looks at managers internally by style. It also follows the categorisations such as Value, Growth and Core provided by US manager performance databases, although these are not adopted by Cambridge rigidly. He says, “growth is such a loose term.”
Nick Samuels said, “We like style with a behavioural, longstanding endorsement. We have a clear philosophy about styles that work. For us, they are value, momentum and quality. There ought to be a behavioural underpinning as to why these styles should continue to work. Humans don’t really change.”
Grace Lavelle, senior associate at consultancy and fiduciary manager, PSolve, said it was important to consider a manager’s style when evaluating their effectiveness. This matters as style in capital markets, can wax and wane in their effect and can have a significant impact on performance.
By removing the effects of style from performance, it is easier to isolate a manager’s stock picking skill and gain a more accurate picture of their added value. Style is also important when it comes to manager selection and asset allocation, with different styles looking more or less attractive at different times.
The conversation then turned to beta, any active strategy’s sensitivity to market movements. Nick Samuels said, ““Beta plus style accounts for a large portion of most portfolio returns. This drives client experience and managers respond accordingly.”
Grace Lavelle agreed that clients can become unhappy with short term underperformance even if caused solely by the manager’s style being out of favour, despite having long term investment horizons.
It is therefore important to present performance against appropriate benchmarks and to have the patience to consider performance relative to a broad market benchmark over the longer term.
Mr Olsen said this is part of the problem looking to style metrics. Managers are judged over one investment cycle instead of the longer term. One well-established mechanism for smoothing returns is to hold managers in the same asset class but with different styles.
On the topic of beta, Clark noted that some of the largest asset owners in the world are now beginning to shun mainstream indices as they prefer to create their own beta, or “move the goalposts”. Many such shifts are caused by responsible investing, which means that environmental, social and governance (ESG) is becoming more influential as these metrics join standard financial metrics in company evaluations.
Sean Thompson, Managing Director, CAMRADATA said, “In investing, style does matter, and has done so increasingly this century. Ever more managers, consultants and sophisticated clients discuss whether Value, Growth, Quality, Momentum or Small Caps are in fashion. Few managers can escape attribution of their returns by reference to style and its many variants.
“While the white paper explores lots of the traps caused by categorisation, there was unanimity that styles are a good thing because they inform understanding of risks and returns. However, it’s important to also note truly active managers ought to be analysed on a wider range of criteria and not boxed in by narrow definitions,” adds Mr Thompson.