Business Matters Tracking investment performance key to successful financial planning

By Kevin FitzGerald

It seems that different types of stocks seem to do better at different times. Is there a way to take advantage of this through selecting different mutual funds?

— J.M. Manhattan

Investment style refers to a manager’s philosophy for selecting securities. The two purest equity investment styles are growth and value.

Because of the cyclical nature of the U.S. economy, value and growth stocks seem to perform well at different times. In other words, when growth stocks are in favor, value stocks may not be, and vice versa. Value stocks often outperform the rest of the market during recovery stages of the general business cycle, and growth stocks often outperform during mature and recessionary stages.

Growth stock managers

Growth stock managers buy companies that have or are expected to have above-average earnings growth. Often these companies are developing new technologies and products, or are well-positioned in a rapidly growing industry. Relative to the overall stock market, growth companies are characterized by basic financial characteristics such as low dividend yields, high price/earnings ratios and high price/book ratios. Growth style is generally appropriate for investors seeking above-average long-term total return, mostly through share price appreciation. Growth stock investors must be able to tolerate a high level of portfolio fluctuation over time.

Value stock managers

Value stocks are those that appear comparatively "cheap" based on various valuation measures. Value managers seek to buy undervalued companies and capture the returns that occur when the market price rises to properly reflect the company’s "hidden" or intrinsic value. Managers measure value in different ways. Some look for companies having below-average price/earnings and/or price/book ratios, others stress above-average dividend yields, and some emphasize a combination of both.

Value managers look for high-quality medium to very large capitalization companies with sound balance sheet characteristics. Value stocks are generally appropriate for investors seeking above-average long-term total return through a combination of capital appreciation plus income. Conservative investors often find value stocks appealing since their above-average dividends can be a major contributor to total return, and many serve as a "cushion" for their share prices if prices temporarily fall out of favor with the market.

Core equity managers

Investors who are undecided about choosing growth or value stocks may find the answer by building a portfolio that combines both growth and value stocks. Sometimes known as core equity portfolios, core equity managers seek to maintain a well-diversified portfolio that blends growth and value. The emphasis is on larger, blue-chip-quality growth companies that have dominant industry positions. The manager adds value compared to the index through superior stock selection and sector weighting differences, usually without making any big "bets." A core equity portfolio is often considered the bedrock foundation on which other specialized investment management styles are built.

Style performance

Individual stocks do not respond equally to economic and fiscal environments. There are periods, often lasting several years, when growth stocks outperform value stocks (and vice versa), large cap stocks outperform small cap stocks, and so on.

Timing investment styles is difficult due to trends in market volatility, interest rates and the economy. Portfolio diversification offers one solution because it increases the opportunity that at least some investments will do well, offsetting others that are lagging. Portfolios generally experience less volatility when they blend investment managers with complementary styles, while long-term performance is usually not hindered.

Keeping track of investment performance is an important step in any successful financial plan. A manager’s style can tell you a lot about what to expect under changing market conditions. There will always be times when one style outperforms another, and times when that same style becomes a laggard relative to others. Investors who understand that related styles tend to produce similar long-term returns are more likely to possess the confidence needed to stay with an investment manager when its style is out of favor. Those who lack an understanding of style may become impatient and bail out of a good long-term investment at the worst possible time.

Growth and value professional

portfolio management

Regardless of whether you select a growth or value approach to investing — or a combination of both — there are professional, full-time portfolio managers available who specialize in value or growth investing. They have the expertise, knowledge and experience to create and actively manage a personalized, diversified growth or value portfolio that is right for you. A financial professional can help you select the specific growth or value manager best suited to meet your investment goals and help you with the ongoing monitoring of a professionally managed portfolio.

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The information contained herein has been obtained from sources believed to be reliable, but we cannot guarantee its accuracy or completeness. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.

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Kevin FitzGerald is first vice president-investments at Paine Webber. He focuses on the areas of professional money management, asset allocation and retirement planning. He can be reached at 1 (800) 654-6162, ext. 448.