1. Investment strategies
Lecture 9

2. Agenda Style strategies Sector strategy Index strategy Global strategy
Stable value strategy
Dollar cost averaging
Value averaging
Dynamic strategies

3. Style strategy Value style Growth style Deep value Relative value
Disciplined growth
Aggressive growth
Choosing securities from the global marketplace, analyzing, evaluating, purchasing and tracking performance of those securities within a diversified portfolio is not something most individual non-professional investors are able or willing to do. Instead, investors can make portfolio allocation decisions by choosing among broad categories of securities, such as "large-cap", "growth", "international" or "emerging markets". This approach to investing - looking at the underlying characteristics common to certain types of investments - is termed style investing.
By classifying assets according to a specific style, investors are also better able to evaluate the performance of professional money managers. In other words, all the money mangers handling emerging growth stock funds can be ranked by performance in that particular category. In fact, money managers are generally evaluated not in terms of absolute performance but relative to a performance benchmark for their style of investing. Over the past decade, a new set of sub-styles, in addition to the usual styles of value and growth, has been accepted by the investment community. These are: deep and relative value and disciplined and aggressive growth.

4. Value Investing
The originator of this conservative approach was Benjamin Graham. His pupil Warren Buffett described Graham’s methods as the used-cigar- butts approach-"Well smoked, down-to-the-nub cigars but they are free- you pick them up and get free puffs out of them."
Value style managers look for stocks that are incorrectly priced given the issuer's exiting assets and earnings. They employ traditional valuation measures that equate a stock's price to the company's intrinsic value. Value companies tend to have relatively low price/earnings ratios, pay higher dividends and have historically more stable stock prices. The value manager's basic assumption is that the issuer's worth will, at some point, be revalued and thereby generate gains for the money manager.

5. Value Investing
His underlying philosophy is that a value investor buys a business rather than a stock. This means that one should invest in businesses, which are easy to comprehend, and where future cash flows are predictable with ‘clock like certainty’.
There are several reasons that a stock might be undervalued: the company may be so small that the stock is thinly traded and doesn't attract much interest; the company is operating in an unpopular industry; the corporate structure is complicated, making analysis difficult or the stock price may not have fully reacted to positive new developments. Value stocks are typically found in slower-growing sectors of the economy like finance and basic industry but there are bargains to be found even in "growth" sectors such as technology.

6. Value Investing
Deep value style uses the traditional Graham and Dodd approach
Relative value money managers seek out stocks that are under- appreciated relative to the market, their peer group, and the company's earnings potential.
New value managers choose their investments from all securities categories, seeking any stock that holds prospect for significant appreciation.
During the 1990s, Standard & Poor's identified three specific sub-styles: deep value, relative value and new value.
Deep Value style uses the traditional Graham and Dodd approach whereby managers buy the cheapest stocks and hold them for long periods in anticipation of a market upswing.
Relative Value money managers seek out stocks that are under-appreciated relative to the market, their peer group, and the company's earnings potential. Relative value stocks should also feature some sort of channel (such as a patent or pending FDA approval) that has the potential to unlock the stock's real value. A typical holding period is three to five years. Unlike traditional value managers, relative value managers pursue opportunities across all economic sectors and may not concentrate on the usual "value sectors".
New value managers choose their investments from all securities categories, seeking any stock that holds prospect for significant appreciation.

7. Growth Investing
Peter Lynch believes that an investor can identify great stocks long before the market does, by using his intuition, intelligence, reflection and perseverance.
Growth style managers typically focus on an issuer's future earnings potential. They try to identify stocks offering the potential for growing earnings at above-average rates. Where value managers look at current earnings and assets, growth managers look to the issuer's future earnings power. Growth is generally associated with greater upside potential relative to style investing and, of course, it has concomitant greater downside risk.

8. Growth investing Traditional growth style Disciplined growth style
Aggressive growth style
Traditional growth style investing has also spawned a few sub styles, specifically, disciplined growth or growth-at-a reasonable-price (GARP), and aggressive, or momentum, growth.
Disciplined growth style managers concentrate on companies that they believe can grow their earnings at a rate higher than the market average and that are selling for an appropriate price.
Aggressive growth styles tend not to rely on traditional valuation methods or fundamental analysis. They rely on technical analysis.

9. Sector strategy Look at a particular industry such as transportation.
Because the holdings of this type of fund are in the same industry, there is an inherent lack of diversification associated with these funds.
Look at a particular industry such as transportation. Because the holdings of this type of fund are in the same industry, there is an inherent lack of diversification associated with these funds. These funds tend to increase substantially in price when there is an increased demand for the product or service offering provided by the businesses in which the funds invest. On the other hand, if there is a downturn in the specific sector in which a sector fund invests, the fund will face heavy losses due to the lack of diversification in its holdings.

10. Index Strategy
Tends to track the index it follows by purchasing the same weights and types of securities in that index, such as an S&P fund.
Tends to track the index it follows by purchasing the same weights and types of securities in that index, such as an S&P fund. Investing in an index fund is a form of passive investing. The primary advantage to such a strategy is the lower management expense ratio on an index fund. Also, a majority of mutual funds fail to beat broad indexes such as the S&P 500.

11. Global Strategy
A global strategist builds a diversified portfolio of securities from any country throughout the globe
(Not to be confused with an international strategy, which may include securities from every other country except the fund's home country.)
A global strategist builds a diversified portfolio of securities from any country throughout the globe (Not to be confused with an international strategy, which may include securities from every other country except the fund's home country.) Global money managers may further concentrate on a particular style or sector or they may choose to allocate investment capital in the same weightings as world market capitalization weights.

12. Stable Value Strategy
The stable value investment style is a conservative fixed income investment strategy.
The stable value investment style is a conservative fixed income investment strategy. A stable value investment manager seeks short-term fixed income securities and guaranteed investment contracts issued by insurance companies. These funds are attractive to investors who want high current income and protection from price volatility caused by movements in interest rates.

13. Dollar-Cost Averaging
Dollar-cost averaging is implemented when an investor commits to investing a fixed dollar amount on a regular basis, usually monthly purchase of shares in a mutual fund.
Dollar-cost averaging is a straightforward, traditional investing methodology. Dollar-cost averaging is implemented when an investor commits to investing a fixed dollar amount on a regular basis, usually monthly purchase of shares in a mutual fund. When the fund's price declines, the investor can buy a greater number of shares for the fixed investment amount, and a lesser number when the share price is moves up. This strategy results in lowering the average cost slightly, assuming the fund fluctuates up and down.

14. Value Averaging
Suppose you are going to invest $200 per month in a mutual fund. At the end of the first month, thanks to a decline in the fund's value, your initial $200 investment has declined to $190. In this case, you would contribute $210 the following month, bringing the value to $400 (2*$200). Similarly, if the fund is worth $430 at the end of the second month, you only put in $170 to bring it up to the $600 target.
This is a strategy in which an investor adjusts the amount invested, up or down, to meet a prescribed target. An example should clarify: Suppose you are going to invest $200 per month in a mutual fund. At the end of the first month, thanks to a decline in the fund's value, your initial $200 investment has declined to $190. In this case, you would contribute $210 the following month, bringing the value to $400 (2*$200). Similarly, if the fund is worth $430 at the end of the second month, you only put in $170 to bring it up to the $600 target. What happens is that compared to dollar cost averaging, you put in more when prices are down, and less when prices are up.

15. Dynamic Strategies buy-and-hold; constant mix;
constant-proportion portfolio insurance; and
option-based portfolio insurance

16. Payoff and Exposure diagrams
Payoff diagram of a given strategy relates to the portfolio performance over a certain period of time to the performance of the stock over the same period.
Exposure diagram relates to the decision of the strategy.

17. Buy-and-hold strategy - an initial
strategy (say, 60/40 stocks/bills) that is bought and then held.
Payoff Diagram
Value of assets ($)
Value of stock mkt
100% stocks
100% Bills
Buy-and-Hold ($100)
100

18. Payoff Example of 60/40 stock/bill
buy-and-hold strategy
Value of assets ($)
slope=0.6 40
value of stock mkt

19. Exposure diagram relates the dollars invested in stocks to total assets; it shows the decision rule.
Buy-and-Hold
Desired stock position ($)
slope=1 (100% in stocks)
100% in bills (slope=0)
Value of assets ($)

20. Exposure Diagram: 60/40 Stock/Bill Buy-and-Hold Strategy
Desired stock position ($)
slope=1 60 40
100
Value of Assets ($)

21. constant-mix Strategies
It maintains an exposure to stocks that is constant proportion of wealth
Dynamic approaches -when the relative values of assets change, purchases and sales are required to return to the desired mix.
Consider a 60/40 stock/bills constant mix strategy (or $60 in stocks and $40 in bills for a total investment of $100).

22. Exposure Diagram for 60/40
constant-mix strategy
Desired stock position 60
slope=0.6
100
Value of Assets

23. Suppose the rule is to set 10% threshold, i
Suppose the rule is to set 10% threshold, i.e, rebalance after 10% increase or decrease in stock price.
For Example: Initial Change Rebalance St. Mkt
Stocks
Bills total assets
Due to “change”
stock/tot. asset =54/94=57.4%
After rebalance (i.e. buy more $2.4 stocks), i.e.,
stock/total asset =56.4/94=60%

24. The general rule of constant-mix strategy is to buy stocks when their prices are falling and to sell stocks when they are rising.
Payoff Diagram of 60/40
constant mix strategy
Value of Assets
Buy-and-Hold
constant-mix 40
Value of stocks

25. When will Constant-mix outperform Buy-and-Hold Strategy?
Consider a case in which stocks fall from 100 to 90, the recover to The market is flat, but it oscillates back and forth.
Buy-and-hold strategy - same
Constant-mix strategy will do better than the buy- and-hold because it buys more stocks as they falls. When shares later increases in prices, the more share purchased will enhance the return for the Constant-Mix Strategy
Other cases include: large volatility and price reversals.

26. Constant-Proportion Strategies
Constant-proportion strategy takes the form: Dollars in stocks = m(Assets - Floor) where m is a fixed multiplier.
Three special cases: (1) If m >1, the strategy is called the constant- proportion portfolio insurance strategy (CPPI). (2) If m=1, floor= value of bills, this strategy is the buy-and-hold strategy. (3) If 0<m<1, floor= 0, the strategy is the constant- mix strategy.

27. Exposure diagram for CPPI
Desired position in stocks 50
slope=m=2
75=floor
100
Value of assets
Dollars in stocks= 2(100-75) =$50 Thus, the initial investment for CPPI is 50/50 stock/bills mix.

28. Under the CPPI, when a stocks fall in price, say from $50 to $45, the total asset value will be $95 (=45+50).
The new appropriate stock position = 2(95-75) = $40, implying sale of $5 of stocks and investment of the proceeds in bills. If stock prices rise in value, stocks should be bought. CPPI strategy sells stocks as they fall and buy stocks as they rise in value.
In a bull/bear market, CPPI will do well as it calls for buying/selling stocks as price rises/falls.
Price reversals hurt CPPI investors because they sell on weakness only to see the market rebound and buy on strength only to see the market weaken.

29. Payoff Diagram for CPPI
value of assets
25/75 buy-and-hold
50/50 buy-and-hold
Value of stock market

30. Concave and Convex Strategies
Strategies that “buy stocks as they fall, and sell stocks when they rise,” giving rise to concave payoff curves are called concave strategies.
Concave strategies do very poorly in flat in down or up market, but tend to do well in oscillating market. Eg: Constant-mix strategies.
Convex strategies are those “buy stocks when they rise or sell stocks when they falls”, e.g.. CPPI strategies
Convex strategies do well down or up market

31. Convex strategies represent the purchase of portfolio insurance
because it has a floor value;
Concave strategies represent the sale of portfolio insurance.
Convex and concave strategies are
mirror images of each other.
When a portfolio combines a convex concave strategies, it results in a buy-and-hold strategy with a linear payoff diagram.

32. Option-based Portfolio Insurance
Option-based portfolio insurance (OBPI) strategies begin by specifying an investment horizon and a desired floor value at that horizon.
The value of the the floor is the present value value of the specified number discounted using the riskless rate.
Strategies involve buying of Tbills and call option. At maturity, the tbills ensure the floor value and option will have upside potential

33. Payoff Diagram for OBPI
value of assets
Value of stock market