Diversification through style selection

Michael John Lytle, chief development officer at exchange-traded product provider Source, agrees: “One style will work in one environment or a particular year and another style will work in another year.

“For example, momentum has been a big factor for four years and value has been an underperforming factor for three out of four years,” he says. “You can see how adjusting your exposure to different factors actually will produce a better outcome than just picking a factor.”

He notes that styles such as value and momentum are “inherent opposites”, so that “going long momentum makes you inherently short value and vice versa”.

George Godber, who is lead manager of the CF Miton UK Value Opportunities fund, says: “From my point of view every investment style has pros and cons. Nothing works the whole time, otherwise everyone would do it. What’s more important is you’re consistent, so that your investors will understand what they get if they buy exposure to your fund.”

He notes that value managers will have different definitions of value and suggests it is a more popular concept in the US than in the UK, where only approximately 4 per cent of funds can be classed as ‘deep value’.

Mr Godber acknowledges that value, like any single investment style, will not perform well in all market environments. “A value style will do poorly when you get bubbles or rampant speculation and hype. That can be in very small parts of the market,” he explains.

For Mr Godber, the pros of a value style include significantly lower volatility than the market, which he claims should make it “a smoother ride”.

“It’s a very instructive, very useful part of an investor’s overall exposure to markets and different styles so not all of their investments are focused in one direction. Over time, if it’s done properly, value is by far and away the best performing style, as demonstrated by [Warren] Buffett, the world’s most successful investor,” he reasons.

In contrast, a behavioural style of investing is likely to deliver outperformance when there are big shifts in the market, according to Colin McLean, managing director at SVM Asset Management.

He adds: “We found that in 2008, with the banks, the market was quite slow to adjust to that. So where there’s a big change, that sort of inertia or anchoring can impact more and there’s much more opportunity.”

Like value, behavioural investing takes various forms depending on the manager. Mr McLean elaborates: “Some of them work on particular failings that they think investors have and they think that leaves some opportunities to be exploited.

“For us, it’s more integrated with how we collect information so it’s a more subtle organisational issue.

“For some [managers], they think investors are rather too quick to take profits. So they tend to cash in on share price moves too quickly on improving companies and I think that’s a favoured approach.”

In spite of his belief in behavioural as a style, Mr McLean admits that momentum investing has worked well for the market in the past year and even over the past five years.

While it pays for investors to understand the correlation between investing styles and market cycles, long-term investors will naturally hope to ride out any short-term volatility. It would seem there is a place for alternative investment styles in an investor’s portfolio.

Ellie Duncan is deputy features editor at Investment Adviser

Manager’s perspective

Tim Gregory, head of global equities, Psigma Investment Management

“It’s very difficult to pick the bottom of short-term cycles, try to ride that wave, and get out at the top. Our view would be if you invest in very good quality businesses for the long run, you may mistime your initial investment but, notwithstanding the vagaries of the market, those investments should do well in the long run.

“If you have a broad portfolio and you want to invest in different styles, there is no right or wrong way to invest per se. If you own a broad spread of different investments and the managers are very good, there will be different times where some perform well and some perform poorly.”