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Pujara vs Raina : it depends on the format of the game
Cheteshwar Pujara is seen as a technically sound batsman, a good replacement for Rahul Dravid in India's Text XI, but doesn't find a place in the Indian ODI and T20 teams. Suresh Raina is one of India's most valuable ODI and T20 players, but is still struggling to establish a place for himself in the Test XI. Virat Kohli on the other hand, seems to get into the groove in any format : 5 day, 1 day or T20. We know this makes Virat Kohli special, but does it make Pujara or Raina bad players? Not really. It just means that selectors will pick Kohli as their man for all formats, but for others like Pujara and Raina, they will look carefully at the skills and style they bring to the table, and decide when to use these skills and when not to. All three are batsmen, all of them want to score the maximum runs each time they get on to the crease - its just that certain formats, certain conditions are more conducive for their style of batting than others.
Similarly, all active equity fund managers have a common goal : beat the designated benchmark and deliver positive alpha year on year. But, each manager has his or her own preferred investing style - a style they are most comfortable with, a style they have maximum conviction in. Some styles work very well in certain market conditions while others produce better results in different circumstances. Fund houses recognize this and strive to have in their teams, a blend of fund management styles : just like an Indian cricket team of 15 who are embarking on a test and ODI tour to Australia, will have a combination of players for all formats to be played in the tour. Once the captain is given his team of 15 for the tour, he picks his 11 for the game at hand, on the basis of the format (test/ODI/T20) and other factors like pitch conditions, opposition weakness against certain types of bowling etc.
In the investing world, you as an advisor have access to a wide variety of equity fund managers, each with their own distinctive investing style. Your job, much like the captain of a cricket team, is to understand the styles of each manager, assess the market conditions, and decide which managers you want to give your clients' money to, in the present market conditions.
To do a good job on this score, you need to have a good understanding of equity fund management styles and know which managers intuitively lean towards which styles. Then you need to know which styles usually work better in which market conditions.
Is your mandate across market cycles or is your fund selection reviewed annually?
But, before we go any further in this discussion, one important aspect that will govern your manager selection is the mandate from your clients to you: Is your mandate genuinely long term, across market cycles, where you can pick funds / fund managers and leave them to deliver over the next 10 years? Or is your implied mandate from your clients an annual review of your own fund selection performance - ie, do you have to demonstrate to your clients that you are picking the right managers for changing market conditions, and delivering alpha through your choices?
The reason this is important is that while there is evidence that suggests that some styles outperform others in particular phases of a market cycle, one can argue that over genuinely long periods of time, say 10 years and above, there is much less evidence that suggests that one style is remarkably superior to another. So, if your mandate from your clients is genuinely long term, you need to worry less about the style, but more about the long term track record of the manager. If however your clients monitor individual fund performance over a 1-3 year time frame, you need to make sure that you have done your homework in terms of identifying appropriate managers for particular phases of the market cycle.
Equity management styles
There are 3 broad styles that are usually visible within the equity management world : growth, value and GARP.
Growth
A growth oriented fund manager typically looks at future earnings growth prospects of the company to determine the best growth picks for his portfolio. He would be relatively less focused on valuation metrics such as price/book value which would give an indicator of whether the stock is undervalued TODAY vs its intrinsic value. He would focus more on what he sees as earnings growth in the future and the price at which he is buying this future growth today.
Value
A value oriented manager, in contrast, will look first at today, and then at the future. He would look for stocks that are trading today at less than their intrinsic worth. This could mean less than book value in some cases or less than replacement cost in other cases (click here to know more about book value vs replacement cost) or simply stocks that are quoting at P/E multiples that are significantly lower than their industry averages. Once he identifies such "out of favour" stocks, he would do his homework to understand whether there is a good reason why it is out of favour and if he can't find a good enough reason, he concludes that this is a case of mispricing and therefore a value buy.
Growth at a reasonable price (GARP)
GARP is a mix between growth and value, in the sense that the fund manager looks for growth oriented stocks but only shortlists those for his portfolio which also qualify as reasonably priced under accepted valuation metrics. A GARP manager would therefore typically avoid "hot" momentum stocks that have already run up a lot, even if future growth prospects seem bright. A pure growth oriented manager on the other hand, may be willing to bet on "concept" stocks that hold significant long term promise, even if current cash flows make the stock look horribly expensive.
Some examples
In our present market context, e-commerce companies are a good case in point. Value oriented managers will not touch them with a barge pole, GARP managers may avoid them because they are no longer available at a reasonable price, but pure growth managers may still be willing to buy them, betting on the transformation in their businesses that they see in the next 3-5 years.
Another example : beaten down commodity stocks may appeal to a value oriented fund manager, may be of no interest to a growth oriented fund manager and may selectively be appealing to a GARP manager, if he sees some prospects of reasonable earnings growth over the next 2-3 years.
Which one is the best?
Now that we have seen the 3 styles, the question is which one is best. As mentioned before, there is little evidence that suggests that one style is remarkably better than the others over an entire market cycle. However, evidence does suggest that value generally outperforms growth in bearish and sideways markets and growth tends to outperform value in a trending bull market. Intuitively also, this makes sense : when markets are not running up in a hurry, the comfort of buying at below intrinsic worth helps put a bottom to a stock price and acts as a good support in falling markets. Value buying would therefore do better than growth focused buying, as growth usually dips in an economic downcycle, which usually corresponds with poor markets. On the flip side, when the economy is picking up and growth is abundant, looking for value buys becomes more challenging and even if you find "out-of-favour" stocks, they may remain so for quite a while, as the market tends to chase growth stories with a vengeance. Value would therefore underperform growth.
Understanding a manager's natural style
How do you figure out a fund manager's style? A simple way is by asking him, or asking your RM to give you the required inputs about each of their manager's styles. Another way is to look at the Performance Consistency Reports in the Fund Trackers section of WF. Take a look at 10 year performance on a Y-o-Y basis and see the years in which a fund outperformed peers and those in which it underperformed peers. Often you find some funds with green and yellow colours in bearish market conditions, but with many more reds in bull market years. The converse is equally true : you will find funds that outperform peers in bull markets, but underperform peers in bearish markets. That should usually give you an initial clue about the fund manager's natural inclination. This may not always be accurate, but it can give you a pointer to start a meaningful conversation with the fund house to understand manager styles.
Once you have understood fund manager styles, you then need to figure out where in a market cycle you think we are. If you are convinced that economic recovery is gaining momentum and growth is in the air, look for managers who are best suited for such conditions. If however you think there's going to be a long road ahead before a sustainable recovery is underway and that too much froth has already been formed in the market, then a growth oriented manager may not be the best person to synchronize with your market view.
Remember, you are the captain, you have a variety of fund management talent available to choose from: you need to take a call on the pitch and the game and choose your fund manager accordingly. There is another option: to hope that all our clients take genuinely long term views on each equity fund holding in their portfolio and stay invested through market cycles. Until such time that this is more hope than reality, you have a task at hand to don the captain's hat and judiciously select a winning team.
Share your thoughts and perspectives
Do you have any observations or insights or perspectives to share on this issue? Did this help you understand the topic better? Do you disagree with some of the observations? Please post your comments in the box below ..... it's YOUR forum !
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