That market’s got style: investing through cycles

Style investing remains a powerful tool in periods of market volatility and, in particular, style analysis reminds investors to be aware of the distinction between overall market risk and stock specific risk. Amanda White spoke with director of Style Research, Robert Schwob.

As the provider of global equity research and portfolio analysis software, the executives of Style Research, spend their days analysing market movements, subsequent portfolio moves and whether managers are being true to
their word. The company provides a range of style, risk and performance analysis facilities and according to director of Style Research, Robert Schwob, there are now a number of interesting dynamics in the market.

While a few months ago Schwob says the market would have leant itself to more passive management, now the opportunity is ripe for good stock selection.

“The market seems to have opened up to active management in the last couple of months, and stock selection seems quite attractive now,” he says. “This highlights the distinction between overall market risk and stock specific risk.”

“One of the interesting features of the market right now, is the disparity of valuations among similar stocks, and usually when that happens the opportunity is fantastic,” he says. “The market is now throwing up some interesting dynamics.”

Style investing has been part of the investing world since Graham and Dodd first introduced value in the 1930s, followed quickly by the introduction of growth by T Rowe Price, and Schwob believes the categorisation of global portfolios according to style remains a legitimate methodology.

Further, he believes looking at style reveals interesting dynamics about investor motivation, fear, greed, trends and risk.

According to Style Research’s definition of style, first published in the Journal of Asset Management in 2000, style exists within markets when there are: “simply identifiable segments of the market with distinguishable patterns of return, where the factors used to identify the various market segments reveal significant elements of security returns, where the patterns of returns are likely to be persistent or systematic and forecastable over a usable investment term, and where these characteristics are not due to the influence of other identifiable characteristics, such as industrial sector influences”.

Founder of Style Research, Schwob is also a director of INQUIRE UK and on the editorial board of the Journal of Asset Management, and he says by recognising that in equity markets there are generally only a few key factor criteria that are systematically related to securities, portfolio, and investment manager performance, they can be analysed to anticipate important factor return trends, trend shifts and their influences on performance.

However he warns that while the intuition may be very similar, basic styles frequently differ considerably from market to market, both in the detail of their factor components as well as in the co-ordination and timing of their cycles.

“While style is an extremely useful concept and a practical analytical tool in global markets, there are notable differences across markets and analysis must remain culturally sensitive to local market characteristics.”

Style Analysis sponsors research at various universities and a recent Cambridge study showed that there are specific cycles that dictate whether value or growth is in ascendancy: interest rate cycle, economic or profit cycle, and the
equity market cycle.

“When interest rates are high, companies with real assets will do well. The market cycle and economic cycle are fairly straight forward, at the top of the economic cycle when there is exuberance the overpromoted growth companies will pull back. Value does well when the equity market begins to turn positive.”

“Now are we at that time? Growth did better than value as we tipped into the recession where you’d rather have  companies with a strong projection of growth. That’s fine until you get to the top of the rollercoaster, when you are in the recession and you hit a pothole, you don’t know how far to go down.”

But regardless of the position in the cycle, Schwob says it is important to see how managers behave through the entire cycle.