11.5 Portfolio Manager Styles: Equity & Fixed Income
Key Takeaways
Active managers try to beat a benchmark; passive managers try to match it at low cost.
Value managers buy shares that look cheap (low P/E or P/B); growth managers buy companies with fast earnings growth even at high valuations.
Sector rotators shift among industries as the business cycle changes; others specialize by market capitalization.
A laddered bond portfolio spreads maturities evenly, a barbell concentrates at short and long maturities, and a bullet concentrates around one maturity.
Interest rate anticipators lengthen duration when they expect rates to fall and shorten it when they expect rates to rise.
Two managers with the same mandate, say Canadian equities, can build very different portfolios because they follow different styles. Knowing a manager's style helps you choose the right benchmark, predict how the portfolio will behave, and combine managers without unintended overlap.
Active vs. Passive Management
| Active management | Passive management | |
|---|---|---|
| Goal | Beat a benchmark after fees | Match a benchmark |
| Methods | Security selection, sector weighting, market timing | Holding the index constituents, or a sample of them |
| Costs | Higher fees and trading costs | Low fees and turnover |
| Belief | Markets are not perfectly efficient | Markets are efficient enough that beating them consistently is unlikely after costs |
Many investors combine the two: a low-cost passive core with active satellite managers.
Equity Management Styles
Top-down vs. bottom-up. A top-down manager starts with the economy and decides which sectors and countries to overweight before choosing stocks. A bottom-up manager focuses on individual companies and lets sector weights result from those choices.
| Style | What the manager looks for | Typical characteristics |
|---|---|---|
| Value | Companies trading below their estimated worth | Low P/E and P/B, higher dividend yield; often out of favour; a contrarian outlook |
| Growth | Companies with above-average earnings growth | High P/E, low dividends, strong revenue and earnings momentum |
| Growth at a reasonable price (GARP) | Growth that is not overpriced | Moderate valuation with solid growth; often uses the PEG ratio |
| Sector rotation | Sectors expected to benefit from the next phase of the cycle | Large sector bets that change over time |
| Market capitalization | Large-, mid- or small-cap companies | Small caps are more volatile and less liquid but can grow faster |
| Quantitative | Stocks ranked by statistical factors | Rules-based, often diversified across many holdings |
Value and growth tend to lead at different times, so a portfolio that holds only one style can lag for years. Style drift, when a manager strays from the stated style, makes it harder for clients to know what they own.
Fixed-Income Management Styles
Bond managers make decisions about maturity, interest rate exposure and credit.
Maturity Structures
| Structure | How maturities are arranged | Feature |
|---|---|---|
| Ladder | Equal amounts maturing each year (for example, 1 to 10 years) | Steady reinvestment; averages out interest rate changes; simple and passive |
| Barbell | Concentrated at short and long maturities, little in the middle | Liquidity from short bonds and yield from long bonds |
| Bullet | Concentrated around one maturity | Matches a known future liability, such as a planned purchase |
Active Fixed-Income Strategies
- Interest rate anticipation: the manager lengthens duration (buying longer or lower-coupon bonds) when expecting rates to fall, and shortens it when expecting rates to rise.
- Credit (spread) strategies: buying corporate bonds whose spreads are expected to narrow, or upgrading quality when a recession is expected and spreads may widen.
- Sector rotation: moving among federal, provincial and corporate bonds as relative value changes.
- Yield curve strategies: positioning for the curve to steepen or flatten.
Passive and Liability-Based Strategies
- Indexing: matching a bond index such as the FTSE Canada Universe Bond Index, usually by sampling.
- Buy and hold: buying bonds and holding them to maturity, often in a ladder.
- Immunization: matching the portfolio's duration to the duration of a future liability so the target amount is reached whatever happens to rates.
Top-Down vs. Bottom-Up
| Approach | Starting point | Typical sequence |
|---|---|---|
| Top-down | The economy | Forecast economic conditions, choose the countries and sectors likely to benefit, then pick the best companies in those sectors |
| Bottom-up | Individual companies | Analyze companies one by one and buy the most attractive, whatever their sector; sector weights result from the stock choices |
Many managers blend the two: they pick stocks from the bottom up but limit sector and country weights based on a top-down view.
Style Drift and Style Analysis
Style drift occurs when a manager departs from the advertised style, for example a value fund that buys expensive growth stocks after a long growth rally. Drift matters because the fund no longer plays its intended role in the client's portfolio, and the client may end up with more overlap and concentration than expected.
Advisors detect drift by checking a fund's holdings against its mandate: average P/E and P/B ratios, dividend yield, market capitalization, sector weights, and how closely returns track value and growth indexes. A fund's style is often summarized in a style box that plots value, blend or growth against large, mid or small capitalization.
Worked Example: Style and Benchmark
In a year when growth stocks rise 25% and value stocks rise 8%, a value manager who returns 10% has beaten the value index by 2 percentage points but trailed the growth index badly. Judged against the right benchmark, the manager added value; judged against the growth index, the same manager looks poor.
Choosing and Evaluating Styles
An advisor should match the style to the client's needs and the benchmark to the style. A value manager should be judged against a value index or a broad index over a full cycle, not against a growth index during a growth rally. Combining managers with different styles (for example, value plus growth, or a ladder plus an active credit manager) can smooth results.
A portfolio manager screens for Canadian companies with low price-to-earnings and price-to-book ratios and above-average dividend yields that are currently out of favour. Which style is this?
Value
Growth
Sector rotation
Momentum
An investor builds a bond portfolio with equal amounts maturing in each of the next ten years and reinvests each maturing bond at the long end. What structure is this, and what is its main benefit?
A bullet, which matches a single future liability
A barbell, which concentrates on short and long bonds
Interest rate anticipation, which bets on falling rates
A ladder, which averages out interest rate changes
A bond manager expects the Bank of Canada to cut rates sharply over the next year. Using an interest rate anticipation strategy, what should the manager do?
Keep duration exactly equal to the benchmark
Shorten portfolio duration by moving into treasury bills and cash equivalents
Sell all bonds and buy preferred shares
Lengthen portfolio duration by buying longer-term or lower-coupon bonds
Sections you finish are checked off in the contents.