From Ranga Chand's Getting Started with Mutual Funds
Many people investing in a mutual fund take little or no account of the investment style of the fund manager. But a particular manager's investment style is not something that should be ignored. Investors are well advised to look at a manager's investment philosophy as well as a fund's past performance figures before making a buying decision. Fund managers usually adhere to one of the following approaches.
These managers look for companies with a good track record of rapid growth in sales and earnings and the potential for more of the same. Typically, a growth stock will have a higher-than-average price-to-earnings ratio and trade at a price well above book value. The belief is that the future growth of the company will, in a relatively short time frame, justify its stock's current high price and provide even higher prices in the future. Growth investments will often be in the small-to-medium-capitalization companies.
Managers who follow a value approach search for assets that are undervalued or where the manager feels the market may not be appreciating the full potential for that company or industry. Typically, these stocks sell at · low price-to-earnings ratios or book value, or may have hidden assets such as real-estate or trademark rights. The strategy is to buy the assets cheap and sell them when their market value rises.
These managers focus on specific industries such as high technology or chemicals that, based on their analysis, will experience the greatest growth. The investment portfolio will then be built around individual companies within these selected industries. Some sector .investors attempt to forecast which areas of a market will do well in the short term. Their strategy is to get in at the bottom before other investors catch on.
Many managers use a blend investment style, employing a combination of value, growth, and sector strategies.
Managers who use a top-down approach first analyse the economy and market outlooks and then select markets and industries that they feel will outperform. These managers are more concerned with the big picture rather than individual companies.
Fund managers who follow a bottom-up management style start by selecting promising individual companies, with little or no emphasis on the larger picture. Only stocks or bonds that meet these managers' investment criteria are purchased. If they can't find what they want, they will hold cash until they do.
Some fund managers combine top-down and bottom-up styles by determining not only the countries and industries in which to invest but also the individual companies.
When actively employed, this technique covers forecasting and analysing the direction of the change in interest rates, the degree of the change across maturities, and the timing of the change. Any anticipated drop in interest rates would dictate an increase in the duration of the bond portfolio, and the opposite action would be called for when rates are expected to rise. The greater the shift of the duration prior to the change in rates, provided the manager's forecast and timing are correct, the greater the incremental returns.
This approach involves switching bond issues to take advantage of higher yields or to decrease risk without adversely affecting the yield. Spread traders analyse and closely monitor credit risk, historical yield relationships, and the yield curve. Unlike interest-rate anticipators, spread traders are very active market participants.
Although many managers remain true to their investment philosophy, others use a combination of two or more styles. None of these investment styles is better or worse, only different. Read the prospectus and annual report or call the fund company if you have any questions on a particular manager's style.