Investment strategy is incredibly important because of the way that investing works. The strategy a fund manager uses is connected to both risk and return. In this article, we’re looking at the most common investment strategies that fund managers use.
We recently looked at whether an active or passive fund is right for your investment outcomes. In this piece, we look at how active fund managers make decisions.
A fund managers’ criteria for asset selection varies by individual manager, the firm they work for and the type of fund they are managing. So, when choosing a fund, you should look closely at the manager’s investment style to make sure it fits your risk-reward profile.
Fundamental or technical analysis
Let’s start with the most common approaches.
Fundamental analysis is the evaluation of everything that affects an asset’s performance. For shares, that means drilling into a company’s financial information to look at profits and free cash flow. It could mean meeting with the board, key staff, advisers and customers. It certainly means comparing to peers.
Fund managers use fundamental analysis to understand what will drive growth.
Technical analysis is based on trading patterns. Fund managers look at trends and movements in an asset’s price. They are looking for support levels where the price of the asset normally settles and points where the price takes off. This is mostly used when looking at commodities like the price of oil or gold.
Fund managers that use technical analysis believe an asset’s price reflects all the information available about it at any single moment. That’s called the efficient market hypothesis.
Top down or bottom up investing
Top down fund managers will invest according to a big theme. For example, when a fund manager anticipates that the economy will grow sharply, they will invest in shares that represent an index that will go up as the economy does.
However, if they believe that a certain sector will benefit from a trend, for example the increased use of renewable energy to counter higher energy costs, they may focus on their investments in assets that will outperform because of that trend.
The risk to look out for is managers being wrong on their big idea. As we have seen over the last two quarters, the UK economy has performed quite well, despite analysts expecting a big slowdown following Brexit. You can read more about this by clicking here. Even if they’re right about the big picture, they may still choose the investments that don’t outperform.
Bottom up managers select based on how specific investments will perform, with less emphasis on the big picture. They will spend more time on researching individual companies. This can still be affected by a market fall pulling even the best shares down.
Fund managers investing for income choose shares with a strong record of earnings and dividends, or a bond that pays a high interest rate. It is used to offset market volatility. Even if the share or bond value goes down, funds can generate a regular cash flow.
The challenge with this approach comes when lots of funds are seeking income, as shares with good dividends can become overvalued. That leads us nicely onto our final approach.
The contrarian approach isn’t generally not for widows and orphans, as contrarian fund managers are looking for unpopular assets that they expect to outperform. They proactively bet against the consensus on that asset.
Warren Buffet is known as a value investor, which means he looks for assets to buy that are undervalued by some statistical measure. Over many years, his approach has beaten growth in assets around the world. However, this approach contains a high market timing risk, that means you must buy the right assets at the right time.
The investment risk is that the consensus was right and your contrarian manager has made the wrong assessment and loses.
In the end, a balanced way of looking at things has lower risks and can take the volatility out of your overall portfolio performance. You should always make sure you invest according to your investment aims and according to your ability to absorb risk. You can read more about getting investments right with our golden rules for investing.
If you would like to get to grips with the types of funds your investments are held in, like taking out the risk or looking for growth, our advisers can help you. Even if you don’t need to make any immediate changes to your assets, contact us today for an initial consultation.
Past performance should not be taken as a guide to future returns and whether you are investing in active or passive funds, you may get back less than you invested.