Investment Style

What Is Investment Style?

Investment style is the method and philosophy followed by an investor or money manager in selecting investments for a portfolio. Investment style is based on several factors and typically tends to be based on parameters such as risk preference, growth vs. value orientation, and/or market cap.

The investment style of a mutual fund helps set expectations for risk and performance potential. Investment style is also an important aspect used by institutional managers in marketing and advertising the fund to investors looking for a specific type of market exposure.

Understanding Investment Styles

Investment styles can range broadly across the market, with institutional investment managers offering investors a large selection of managed fund strategies for various allocations of a portfolio. Institutional investment styles can first be generally segregated by risk. Risk and the risk allocation fit for investors is typically a primary differentiator that helps mutual fund companies market to investors. Investors will typically begin their investing style choices by first considering their risk tolerancewhich can be either conservative, moderate or aggressive. Among these categories, investment managers can offer both active and passive investment strategies that broaden the investment options even further for investors.

In addition to risk tolerance, investment style can describe the type of investments that a portfolio has. For instance, investment style may be dictated by market capitalization (large-cap), mid-cap, small-cap) or whether a stock is growth vs. value.

Investment style is important for investors choosing a mutual fund. A style box is a graphical representation of a mutual fund’s characteristics. The financial services research provider Morningstar, Inc. popularized this tool by placing it alongside its well-known mutual fund ratings system, which ranks mutual funds by assigning them between one and five stars. As a result, many mutual fund investors have become familiar with the style box and its use as a tool for evaluating mutual funds. At the same time, a style box is a tool with several other practical applications. Read on to find out how style boxes can be used to categorize mutual funds and individual securities and to help you understand money management and the asset allocation strategy of your portfolio.

Growth vs. Value

Investment style is often distinguished by growth versus value. Growth stocks are considered stocks that have the potential to outperform the overall market over time because of their future potential, while value stocks are classified as stocks that are currently trading below what they are really worth and will, therefore, provide a superior return. The decision to invest in growth vs. value stocks is ultimately left to an individual investor’s preference, as well as their personal risk tolerance, investment goalsand time horizon. It should be noted that over shorter periods, the performance of either growth or value will also depend in large part upon the point in the cycle that the market happens to be in.

Risk-Based Investment Styles

Conservative

Conservative funds will often have investment styles focused around income and fixed income investments. Investments in this category can include money market funds, loan funds and bond funds. Conservative funds are generally good as income investments as well, with many paying interest distributions or reinvesting in capital appreciation growth.

In the fixed income category, managers will focus on offering funds by duration and credit quality. While fixed income credit investments are generally considered conservative, higher yielding lower-credit-quality investments would be the most aggressive style of funds offered for investors with conservative to moderate risk tolerance.

Moderate

Many moderate risk investors will be attracted to managed funds with large-cap, blue chip securities or a value investment style. Large-cap, blue chip stocks can attract income investors since they are mature businesses with committed dividend payout ratios and steady dividends. Value funds may offer income as well. Generally value stocks have moderate risk with fundamental characteristics that show their market values discounted from their intrinsic value. Based on deep fundamental analysis and long-term assumptions, value investments can be a good core holding for all types of investors and are especially attractive in the moderate risk category.

Aggressive

Growth funds, aggressive growth fundscapital opportunity funds and alternative hedge fund investment styles that have broader flexibility to utilize leverage and derivatives are some of the most appealing managed fund investment styles for aggressive investors. These funds are typically actively managed funds that seek to outperform market benchmarks. Aggressive funds may also encompass broad investment universes for greater return potential. In some cases this can include global securities or international securities actively managed and focused on high growth regions of the world, such as the emerging markets, BRIC countries or Asia ex-Japan.

Investment Style Disclosures

Funds managed by all types of investment managers in the investment industry include investment documents that provide in-depth details on a fund’s investment style. Registered funds are more transparent, as directed by the Securities Act of 1933 and the Investment Company Act of 1940. Hedge funds and other alternative funds will also provide investment style disclosures in various forms for their investors.

In the registered universe, funds must file a prospectus and statement of additional information with their registration. A fund’s prospectus is typically the primary source of information for investors seeking to understand a fund’s investment style. Along with investment style, the prospectus will also disclose details about the levels of risk an investor can expect with the fund and the types of investors who would find the fund to be the best fit.