At MLC, one of the key considerations we take into account when combining managers in a portfolio is their ‘investment style’ – a term commonly used to describe their investment process and the stocks they select.
Popular styles you may have heard of are value and growth or also could be size (small cap) and momentum, which have also been around for a long time. Others, like quality or low volatility have become more recognised styles recently.
MSCI Inc – a world leading provider of indexing and investment risk-modelling – has outlined the following styles in Table 1 and the factors which define them, based on the MSCI Factor Classification Standard (FaCS). While there are a variety of style definitions across the industry, we use MSCI’s definitions to analyse our global equity managers and to construct our multi-manager portfolios.
How much does style influence a manager?
A couple of years ago, in an article published in The Journal of Portfolio Management, Kahn and Lemmon from BlackRock, Inc. analysed a large selection of 138 global equity managers. They found on average 35% of the active risk (a measure of holdings relative to benchmark) of the managers’ portfolios could be explained by their styles, with the other 65% being driven by the managers’ macro, industry, country and stock specific positions.
In turn, we completed a similar research project analysing the active global equity managers we employed. As a large asset owner we are in a rather unique position as we have daily access to the stock-level holdings of all the managers we use; allowing us to undertake really deep analysis.
Our findings very much supported Kahn and Lemmon’s results, as we found that the majority of our managers have a 30% to 40% exposure to styles. Interestingly, we also discovered that although style is a separate driver of returns to both country and industry allocations, a manager’s style can heavily influence these allocations.
Being in style vs out of style
You can see in Chart 1 an example of typical global equity managers’ portfolios vs value and growth styles of investment. The two managers are Kiltearn, a deep value manager and Intermede, a manager with a growth-based investment process. Noting that a measurement outside +/- 0.20% is considered a significant bias, not only do both managers have consistent positive exposures to their ‘defining’ styles but they are also consistently ‘short’ (negatively exposed) to the opposite style of investment.
This is a very important point because here you can see that not only is a manager’s prevailing style a contributor to their performance, but just as influential is their negative relationship to other styles ie their ‘anti-style’ bias. This means that not only is Kiltearn a value manager, but they are also an anti-growth manager. Like Intermede is a growth-focused manager with an anti-value bias.
Style performance in recent years
The last few years have been very volatile in terms of major styles performance - Chart 2 below follows style performance year-by-year since 2015.
As you can observe, 2015 was an excellent year for growth style but a negative one for value. In 2016 things changed – it was a very strong year for value, growth was up as well but significantly underperformed value. 2017 was another year of growth and, finally, in 2018 both value and growth were down.
Chart 3 presents performance of Kiltearn and Intermede over the same period. Clearly their performance, relative to the benchmark and to each other, has been strongly affected by the style environment, either providing a strong tailwind (Kiltearn – as a value manager – in 2016, Intermede – as a growth manager – in 2017 and again in 2018) or an equally strong headwind (Intermede in 2016, Kiltearn in 2015 and since 2017).
A multi-manager approach can help
As you can see, the difference between value and growth is generally volatile and, perhaps, unpredictable. However, the average of value and growth is much more reliable and historically has been mostly positive. As shown in Chart 4, since 1995 – out of 24 calendar years of observations – there have been only three years when the average was negative or close to zero.
On a conscious note, one of the two negative years was actually last year – not the best investment environment but, judging by the chart, a transitional and rather rare occasion.
So while prevailing style and ‘anti-style’ does contribute significantly to the risk and performance of traditional equity managers, through active management we can select managers who not only deliver positive performance due to their individual style exposures but combine it with other sources of alpha like stock selection. We also combine specifically selected managers in carefully constructed multi-manager portfolios to effectively work together with the aim of delivering superior risk-adjusted performance for our clients.
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