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Style counsel

The rationale behind style investing is that, over time, stockmarkets

clearly and consistently reward certain attributes or styles.

Research shows that the most consistent outperforming stocks over the

longer term have been companies with stylistic attributes which can be best

categorised as belonging to either the extreme growth or extreme value end

of the market. Style investing recognises this fact. It accepts that

stockmarkets are segmented and that stocks do not behave identically.

Typically, every stock goes through a growth and a value phase. Growth

stocks are companies which have the potential to grow their earnings

rapidly and increase the value of their shares over time. Usually, these

companies are young and vibrant, expanding quickly into new markets or

developing highly sought after new products.

Value stocks, on the other hand, are companies where the share price is

depressed for one reason or another but which investors believe will

eventually rise – with the help of a catalyst – to reflect their intrinsic

value. Such companies are usually more mature, operating in developed

markets with little room to grow organically.

When buying value stocks, investors like to feel they have bought a

bargain that everyone else has missed. They expect that others will

eventually recognise the true value of the stock, causing its price to


However, low prices alone do not indicate an undervalued asset. The key to

identifying the best-value companies is to recognise when a stock is cheap

for a good reason, avoiding companies which are potentiallybankrupt. If

supported by strong fundamentals, a catalyst will enable the market to

unlocktheir intrinsic value.

This catalyst could be a change in the company&#39s management or a

beneficial change in the economic environment.

Good style investors will look for inefficiencies in the market to

maximise growth potential. For example, in the case of value stocks,

investors may be able, through close analysis, to buy a company where the

shares have been oversold. This may be because it is perceived that its

earnings will remain depressed.

However, if a catalyst can be spotted early, these stocks can experience

dramatic reratings against the stockmarket as a whole, hence the


Investors buy growth stocks on good news, such as an earnings&#39 upgrade, in

the expectation that, over time, the price of a stock will rise to reflect

its improved future earnings potential. Given that extreme growth stocks

have much higher ratings than the market as a whole, any bad news that may

lead to an earnings&#39 slowdown can rapidly lead to a stock being torpedoed.

But good news flow will lead to positive reratings and substantial growth

in the com-pany&#39s share price. The inefficiency this time is the timelag

before the market prices in good news, opening a window of opportunity to

buy the stock before it rises.

Style funds concentrating on growth or value are particularly useful to

investors because stockmarkets often experience sector rotations that

result in a change of leadership between growth and value stocks. An

example is technology stocks, many of which are currently at the extreme

growth end of the market and considerably outperformed the wider market in

the six-month period between October 1999 and March 2000.

Their rise resulted in many stockmarket indices becoming bloated with

technology and many portfolios that use them as a benchmark are now

particularly growth-oriented.

As a result, many investment portfolios have become highly dependent on

growth stocks, leaving little room for exposure to value companies. But

there are now many attractively valued companies available in the wider

universe of stocks which have been ignored in the rush for technology.

Astute investors will seek to acquire shares in these neglected companies,

many of which are well managed and have solid future prospects but do not

yet reflect this in their valuations.

The last sector shift from growth to value took place in the spring of

1999 and resulted in considerable outperformance for value-oriented

investors but left growth investors badly exposed.

Clearly, a single focus on growth or value stocks will not provide

outperformance all the time. However, with the help of style funds,

investors have the opportunity to balance their portfolios between growth

and value, so they are not caught out by a change in stockmarket fashion.

Alternatively, they can choose to follow the style that is popular with

the market at any one particular point. Whatever the choice, style funds

are an excellent addition to the investment armoury of any serious

stock-market investor.


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