Investment Strategy

An investment strategy defines and guides investors on selection of an investment portfolio. The guidance is based on investment goals, future needs, risk tolerance and personal preference. While there can be many types of strategies, there are five broad categories an investor can fit in.

• Balanced

• Growth

• Income

• Value

Balanced

As the name implies, a balanced investment strategy is applied to balance the risk-return profile of a portfolio. The strategy can be applied by combining asset classes and diversifying with sectors and geographies. Typically, investors refer to a balanced portfolio as the one divided between stocks and bonds (and some cash), however that may not always be the case. The idea is to invest in asset classes that have little to no correlation between them and across sectors and geographies that maximize diversification. Investments can be diversified amongst large-cap and small-cap, value vs growth, or developed vs emerging. Each segment with a different risk-reward profile and exposure benefits. Within bonds, investments can come from government securities such as T-bills or treasury notes, corporate bonds, and municipal bonds. Corporate bonds are subject to credit and interest rate risks. Investors typically keep a small cash balance in their portfolios (can range from 3% to 15% of the portfolio) which might not do much for a portfolio in a hindsight but can be used as a hedging or purchasing power at times. Cash accounts in GICs, or high saving accounts can act as inflation hedge and with the liquidity offered by such accounts can be used for purchasing securities when such opportunities arise. Individual weightings are a personal choice and depend on several factors.

Growth

A growth portfolio is another diversified investment strategy wherein the primary focus is on stocks that have potential for capital appreciation with little or no dividend payouts. The investments can be long-term or medium-term and typically consists of companies in the small- to mid-market capitalization range. The focus in stock selection is to identify companies that exhibit above-average growth via acquisitions, R&D (research and development), business expansion, or market penetration. Investors that follow the growth strategy closely watch company news, emerging industry segments, and economic and market trends. Growth stocks tend to be the ones that hold a promising start or expansive capabilities in niche or new industry segments and are often the ones investors are willing to pay high multiples for given the optimism behind the stock. With a growth-focused portfolio, investors would have to get comfortable with volatility and premium valuations. For stock selection, investors can screen the market for companies such as high earnings per share or sales growth in the recent history, above-average operating and profitability margins, or above-average capital efficiency by measure of Return on Invested Capital. Some growth stocks can have net losses for years; however, investors are willing to overlook that for long-term capital appreciation benefits. A growth portfolio could be all equity or have some exposure to fixed income.

Value

Value investing takes up different meaning for different investors. For some, mature companies in stable industries may mean ‘value’, for some undervalued in valuation terms mean value, and for some just any long-term investment with strong fundamentals mean value. The definition is very subjective with a common underlying theme that the investment is long-term and requires some due diligence for stock selection. In essence, however, investing in value stocks means investing in companies with a price that appears to be low or ‘cheaper’ relative to the company’s fundamentals such as book value, cash flows, and assets. Common characteristics of value stocks include high dividend yield, low price-to-book ratio (P/B ratio), and a low price-to-earnings ratio (P/E ratio). Value investors equate their strategy to buying a dollar for 50 to 60 cents. They assume this limits downside risk and still offers investment performance potential. Value stocks tend to be less volatile, pay dividends, and cause less stress overall to investors. But there are times where they underperform the market.

Income

An income portfolio is a type of investment strategy that invests primarily in equity and debt securities with the aim of receiving cash flows and capital preservation. The cash flows can be money received in the form of dividends, interest income, capital gains distribution (self-made of through ETFs) or investments (income-producing investments include real estate). Dividends and capital gains are typically taxed at a lower rate than earned income, and investors opt for income portfolios to provide a steady stream of income. An income portfolio usually consists of dividend-paying stocks and coupon-yielding bonds.

Invest and diversify!

Barkha Rani

Analyst for 5i Research