The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

EQUITY STYLE MANAGEMENT

Before we discuss the various types of active and passive strategies, let’s discuss an important topic regarding what has come to be known as equity investment styles. Several academic studies found that there were categories of stocks that had similar characteristics and performance patterns. Moreover, the returns of these stock categories performed differently than other categories of stocks. That is, the returns of stocks within a category were highly correlated and the returns between categories of stocks were relatively uncorrelated. As a result of these studies, practitioners began to view these categories of stocks with similar performance as a “style” of investing. Using size as a basis for categorizing style, some managers became “large cap” investors while others “small cap” investors. (“Cap” means market capitalization.) Moreover, there was a commonly held belief that a manager could shift “styles” to enhance performance return. Today, the notion of an equity investment style is widely accepted in the investment community. There are three major services that provide popular style indexes.

Types of Equity Styles

Stocks can be classified by style in many ways. The most common is in terms of one or more measures of “growth” and “value.” Within a growth and value style there is often a substyle based on some measure of size. The motivation for the value/growth style categories can be explained in terms of the most common measure for classifying ...