* Active Management
Manager most often rely on two basic economic approaches to building portfolios. A bottom-up approach examines the market on an individual stock basis and chooses those stocks with the highest potential return. A top down approach analyzes the economy and determines which sectors are best positioned to prosper within current economic expectations.
Manager further defines his investment style by types of stocks he buys. Traditional value managers buy stocks whose current market price is substantially less than the calculated intrinsic value. Managers calculate intrinsic value by using company assets, cash flow, earnings per share or a combination of these variables. Value portfolios generally hold stocks whose P/E ratio is less than the S/P 500 and dividend yield is greater than the S&P 500. Value managers focus on fundamentals, which usually limits volatility during turbulent markets.
Manager buys stocks whose growth rates in sales have been, or are expected to be, greater than most companies. New technology, a proprietary product or being well positioned within a growth industry, can all contribute to a company's accelerated growth rate. Growth portfolios generally contain stocks whose earnings growth and return on equity are greater than the S&P 500.
* Value and Growth
Manager may further define style by concentrating on the market capitilzation of the companies purchased. By concentrating in small, mid or large capitilization companies, a manager attempts to improve performance. This additional concentration may bring higher than expected performance in good markets, but result in unforeseen risks in a down market. For example, small cap companies, whether growth or value, inherently offer greater potential than large cap companies. However, the primary consideration is the amount of risk customers are willing to assume for a higher payout.
* Beyond Traditional
Manager utilizes several styles beyond growth and value. Sector rotational managers concentrate their portfolios in favorable sectors of the market. The manager's success relies on his ability to predict various economic stages and the impact of these stages on underlying stock prices. Although sector managers use a top-down approach to implement this style, portfolios can exhibit growth or value characteristics.
* Market Timing
Manager positions the portfolio in or out of the market (usually the stock market) based on expectations of market direction. The manager's success relies on his ability to be fully invested during rising markets and predominantly in cash during market declines.
Manager positions his portfolios to beat the market by a modest margin. The manager's success relies on the ability to buy a large group of stocks that fare better than the market as a whole. No particular bais occurs in his portfolio with respect to sector weighting, growth or value discipline or economic forecasts.
Manager positions his portfolios in industry groups or companies that are currently underperforming or trading at a discount to the rest of the market. The manager's success relies on his ability to identify out of favor companies and industries with the greatest potential for turnaround. Psychologically investors may find this style difficult to embrace. The manager is knowingly buying companies currently in trouble and may require a great deal of patience for the expected turnaround to produce desired rates of return.
Financial Planning On Wall Street (Dec. 1994)