Jonathan Davis: Time to add a little bit of style to your portfolio

How many investors in the UK think hard about the way in which their portfolios of shares or funds are made up? In practice, it seems, precious few. Most investors make some buy-or-sell decisions once or twice a year based on what they (or advisers) think represents good value at that moment. Not many stop to look back at either the overall shape of their portfolios, which will inevitably get pulled out of balance as the years pass, or at the components of the returns that they have actually achieved.

How many investors in the UK think hard about the way in which their portfolios of shares or funds are made up? In practice, it seems, precious few. Most investors make some buy-or-sell decisions once or twice a year based on what they (or advisers) think represents good value at that moment. Not many stop to look back at either the overall shape of their portfolios, which will inevitably get pulled out of balance as the years pass, or at the components of the returns that they have actually achieved.

As a result, they end up being collectors of funds and shares, rather than, ideally, disciplined investors who know more precisely what bets they are taking and what risks they are running.

Such analysis, for those who have the know-how and patience to undertake it, can lead to surprising results. In the UK retail investor market, for example, it is well known that the majority of those who own shares tend to own just one or two, which they have typically acquired through privatisation or demutualisation. This inevitably gives them a lopsided set of holdings, and ensures their investments are more exposed to certain types of market conditions than others.

In the fund market, equally, the data suggests many investors are drawn like moths to a flame towards the beacon of high-growth funds, typically those that specialise in small to medium capitalisation shares, or, more recently, those with specialist mandates such as technology. The average unit trust in the All Companies sector has a very different set of characteristics to the stock market as a whole, being on average underweight in large capitalisation shares and having above-average volatility.

Why this should be so isa matter of debate. Some will say it is mainly the result of the tendency of new investor money to follow strong recent performance, regardless of the underlying investment merit of what they are buying. Others may prefer to look towards the financial incentives built into the commission-based advisory and intermediary system we operate in this country.

Experience suggests it is much easier to sell investors a fund that promises high growth - but has high charges - than it is to flog someone a conservatively managed and low-cost value fund, even though the latter in investment terms may prove to be a tortoise and the former a hare.

The one thing that seems certain is that most investors do not really appreciate exactly what it is they are buying. In the United States, where the concept of style investing and style analysis is more developed than it is over here, investors have a better grasp of what kind of share or fund they are buying.

One big question exercising professionals in the investment business in Europe is how far, and how quickly, investors can be persuaded to buy into this new way of thinking about investment in the UK. Schroders, for example, has launched a range of funds that invest according to certain style criteria, and many other groups are looking to market funds on a similar basis.

What is style analysis? It amounts to no more than breaking down and looking hard at the main factors contributing to the overall movements in a market. The same analysis can be applied to the behaviour of a particular fund manager. The most important "style factors" at work in a market are size (large versus small companies) and "value versus growth" effects. Other factors include momentum and gearing. Value and growth in turn can be broken down into several component criteria - high dividend yield and low p/e ratios, for example, in the case of value, and high returns on equity and so on in the case of growth.

On size, there is well-documented evidence that at different times markets tend to favour either large capitalisation or smaller capitalised companies. During these periods, the behaviour of a share will be influenced to a significant degree not just by its fundamental record of earnings, dividends and so on, but directly as a result of whether it has a larger-than-average, or smaller-than-average, market capitalisation. Investors who do not have the right kind of bias in their portfolios will be penalised, while those who do will benefit as a result. As for value versus growth, the distinction between a value share and a growth share has been talked about since at least the 1930s. But it has taken the advent of computing power - coupled with the research of a number of leading academics in the US - to turn this difference into a measurable characteristic that can be applied to whole portfolios and funds, as well as to individual shares.

In the US, most funds now market themselves explicitly by reference to a style matrix devised by the fund-rating company Morningstar. This is a device by which every fund is classified into one of nine style boxes, which are based on how a fund stacks up against the "large versus small cap" and "growth versus value" benchmarks.

In the UK, says Style Research, an investment research boutique that analyses the behaviour of markets and fund managers against sophisticated style criteria, there is evidence that the UK is starting to move down the path towards definable styles in the stock market. The graphs I show here are examples of how style analysis can illuminate what has been happening in the markets in recent periods.

The UK market has been dancing fairly consistently to a tune of growth, momentum and large cap stocks for most of the 1990s.

When the graphs slope upwards, they show a particular style factor has produced above-average returns relative to the market, while one that slopes downwards shows the opposite. So buying stocks with above-average dividend yields - a typical value criterion - has largely led to underperformance, while buying stocks with above average market capitalisation (a size effect) or strong recent share price performance (a momentum effect) has tended to produce above average gains.

As you can see from the charts, this well-established trend appears to have turned sharply in the last 12 months. Is this a blip or the start of a longer and more enduring trend?

Robert Schwob of Style Research argues that it is too early to be sure. The picture is mixed, and the style indicators may be reflecting a complex cross-current of underlying effects. What seems to be happening is that, after the tech stock shock, investors are hunting around for companies that have stable and reliable earnings growth regardless of other criteria.

The key for investors is that if the style barometer is set to change, the rules of the game of the last few years, which have overwhelmingly favoured a certain style of fund and share, will also change. I hope to return again shortly to this interesting subject, as my sense is that style factors are set to increase in importance and awareness over the next few years.

davisbiz@aol.com

Life and Style
“What is it like being a girl?” was the question on the lips of one inquisitive Reddit user this week
News
peopleDave Legeno, the actor who played werewolf Fenrir Greyback in the Harry Potter films, has died
Arts and Entertainment
Armando Iannucci, the creator of 'The Thick of It' says he has
tvArmando Iannucci to concentrate on US show Veep
Life and Style
beauty
PROMOTED VIDEO
Sport
Luis Suarez looks towards the crowd during the 2-1 victory over England
transfers
Life and Style
Swimsuit, £245, by Agent Provocateur
fashion

Diving in at the deep end is no excuse for shirking the style stakes

Sport
German supporters (left) and Argentina fans
world cup 2014Final gives England fans a choice between to old enemies
Arts and Entertainment
A still from the worldwide Dawn of the Planet of the Apes trailer debut
film
News
peopleMario Balotelli poses with 'shotgun' in controversial Instagram pic
News
A mugshot of Ian Watkins released by South Wales Police following his guilty pleas
peopleBandmates open up about abuse
Sport
Basketball superstar LeBron James gets into his stride for the Cleveland Cavaliers
sportNBA superstar announces decision to return to Cleveland Cavaliers
Sport
Javier Mascherano of Argentina tackles Arjen Robben of the Netherlands as he attempts a shot
world cup 2014
Arts and Entertainment
The successful ITV drama Broadchurch starring David Tenant and Olivia Coleman came to an end tonight
tv
Sport
Four ski officials in Slovenia have been suspended following allegations of results rigging
sportFour Slovenian officials suspended after allegations they helped violinist get slalom place
News
14 March 2011: George Clooney testifies before the Senate Foreign Relations Committee during a hearing titled 'Sudan and South Sudan: Independence and Insecurity.' Clooney is co-founder of the Satellite Sentinel Project which uses private satellites to collect evidence of crimes against civilian populations in Sudan
people
Arts and Entertainment
Balaban is indirectly responsible for the existence of Downton Abbey, having first discovered Julian Fellowes' talents as a screenwriter
tvCast members told to lose weight after snacking on set
Life and Style
More than half of young adults have engaged in 'unwanted but consensual sexting with a committed partner,' according to research
tech
Life and Style
A binge is classed as four or more alcoholic drinks for women and five or more for men, consumed over a roughly two-hour period
tech
Finacial products from our partners
Property search
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    BC2

    £50000 - £70000 per annum: Harrington Starr: Business Analyst Consultant (Fina...

    Programme Support, Coms, Bristol, £300-350p/d

    £300 - £350 per day + competitive: Orgtel: My client, a leading bank, is curre...

    (Junior) IT Systems Administrator / Infrastructure Analyst

    £28000 - £32000 per annum + pension, 25 days holiday: Ashdown Group: A highly ...

    Finance Officer

    Negotiable: Randstad Education Birmingham: Randstad Education are seeking a Fi...

    Day In a Page

    A History of the First World War in 100 Moments: Peace without magnanimity - the summit in a railway siding that ended the fighting

    A History of the First World War in 100 Moments

    Peace without magnanimity - the summit in a railway siding that ended the fighting
    Scottish independence: How the Commonwealth Games could swing the vote

    Scottish independence: How the Commonwealth Games could swing the vote

    In the final part of our series, Chris Green arrives in Glasgow - a host city struggling to keep the politics out of its celebration of sport
    Out in the cold: A writer spends a night on the streets and hears the stories of the homeless

    A writer spends a night on the streets

    Rough sleepers - the homeless, the destitute and the drunk - exist in every city. Will Nicoll meets those whose luck has run out
    Striking new stations, high-speed links and (whisper it) better services - the UK's railways are entering a new golden age

    UK's railways are entering a new golden age

    New stations are opening across the country and our railways appear to be entering an era not seen in Britain since the early 1950s
    Conchita Wurst becomes a 'bride' on the Paris catwalk - and proves there is life after Eurovision

    Conchita becomes a 'bride' on Paris catwalk

    Alexander Fury salutes the Eurovision Song Contest winner's latest triumph
    Pétanque World Championship in Marseilles hit by

    Pétanque 'world cup' hit by death threats

    This year's most acrimonious sporting event took place in France, not Brazil. How did pétanque get so passionate?
    Whelks are healthy, versatile and sustainable - so why did we stop eating them in the UK?

    Why did we stop eating whelks?

    Whelks were the Victorian equivalent of the donor kebab and our stocks are abundant. So why do we now export them all to the Far East?
    10 best women's sunglasses

    In the shade: 10 best women's sunglasses

    From luxury bespoke eyewear to fun festival sunnies, we round up the shades to be seen in this summer
    Germany vs Argentina World Cup 2014: Lionel Messi? Javier Mascherano is key for Argentina...

    World Cup final: Messi? Mascherano is key for Argentina...

    No 10 is always centre of attention but Barça team-mate is just as crucial to finalists’ hopes
    Siobhan-Marie O’Connor: Swimmer knows she needs Glasgow joy on road to Rio

    Siobhan-Marie O’Connor: Swimmer needs Glasgow joy on road to Rio

    18-year-old says this month’s Commonwealth Games are a key staging post in her career before time slips away
    The true Gaza back-story that the Israelis aren’t telling this week

    The true Gaza back-story that the Israelis aren’t telling this week

    A future Palestine state will have no borders and be an enclave within Israel, surrounded on all sides by Israeli-held territory, says Robert Fisk
    A History of the First World War in 100 Moments: The German people demand an end to the fighting

    A History of the First World War in 100 Moments

    The German people demand an end to the fighting
    New play by Oscar Wilde's grandson reveals what the Irish wit said at his trials

    New play reveals what Oscar Wilde said at trials

    For a century, what Wilde actually said at his trials was a mystery. But the recent discovery of shorthand notes changed that. Now his grandson Merlin Holland has turned them into a play
    Can scientists save the world's sea life from

    Can scientists save our sea life?

    By the end of the century, the only living things left in our oceans could be plankton and jellyfish. Alex Renton meets the scientists who are trying to turn the tide
    Richard III, Trafalgar Studios, review: Martin Freeman gives highly intelligent performance

    Richard III review

    Martin Freeman’s psychotic monarch is big on mockery but wanting in malice