Clark Wealth Management Group - ScotiaMcLeod Fredericton

Diversifying your investment portfolio has always been important but in light of the current level of volatility in all markets, it’s even more critical today. In addition to the obvious diversification between asset class and geography, various equity investment “styles” have a place in your portfolio. A portfolio weighted too heavily toward one style over another will behave like a feast or famine portfolio.

There are basically four different styles of equity management. They are value, growth, momentum and passive (or indexing).  During the cycles of any market, there are times when each of these styles will do better than the others. Because we never know when that will happen until after it has, it is important to be diversified by investments style too.

Value investing is considered the most conservative style. Value managers tend to look for companies that are trading for less than their book value, with a low price to earnings ratio, and a strong debt to equity position, and high dividend payout.

On the surface, you would think value investing would be the best approach however the strategy doesn’t win all the time. For example, the recent run-up in commodity prices has left many value managers in the dust because they don’t typically own cyclical, non-dividend paying stocks such as junior mining and resource issues.

Growth managers seek out companies that are growing faster than the market. They are far less concerned about things like a company’s price to earnings ratio because they are willing to pay a premium for rapid growth. These companies generally do not pay any dividends to investors choosing instead to plow every bit of free cash-flow back into the business to maintain the rapid rate of growth. Pure growth managers will often trade their portfolios relatively frequently around small market price changes.
 
Momentum managers follow trends. Momentum managers believe that when a stock or industry sector moves strongly in a particular direction, the path of least resistance will continue in the same direction. This approach worked pretty well recently for those willing to bet the farm in the commodity space. To value investors this looks a lot like the “lemming effect” where regardless of the rational evidence, momentum investors follow the market hoping to sell to a greater fool at some point. The difficulty with momentum investing is trying to establish a reasonable price at which to either buy or sell a stock.

Momentum managers tend to be more aggressive therefore their funds are usually higher-risk with returns that reflect that. Costs of this approach can also be higher due to the frequent trading required to follow the momentum of the market.

Passive equity investing is as you’d expect. A manager of an index fund or ETF will buy the exact holdings of a market index complete with the same market weighting and simply track the market’s performance. The vast majority of exchange traded funds (ETFs) are passively managed.

Maintaining an appropriately balanced and diversified portfolio is important in the face of all the financial uncertainty in the world. Paying attention to investment style is just another step in that direction.

Keir Clark, is a senior wealth advisor, with Clark Wealth Management Group and branch manager at ScotiaMcLeod in Fredericton, NB. He can be reached online at www.keirclark.ca or by telephone at 506-450-6465.

Information and opinions contained herein have been compiled from sources believed reliable but no representation or warranty, expressed or implied, is made as to the accuracy or completeness.