Style Investing
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Style investing is an investment approach in which securities are grouped into categories and portfolio allocation based on selection among styles rather than among individual securities. Style investors can make portfolio allocation decisions by placing their money in broad categories of assets, such as small-cap, value, low-volatility, or
emerging markets An emerging market (or an emerging country or an emerging economy) is a market that has some characteristics of a developed market, but does not fully meet its standards. This includes markets that may become developed markets in the future or were ...
. Some investors dynamically allocate across different styles and move funds back and forth between these styles depending on their expected performance.


Asset pricing

Style investing can be used in the study of asset prices and can serve as a useful framework for identifying anomalous price movements in stocks and study the relation between risk and return in
asset pricing models In financial economics, asset pricing refers to a formal treatment and development of two main pricing principles, outlined below, together with the resultant models. There have been many models developed for different situations, but correspon ...
. Style investing generates co-movement between individual assets and their styles. Momentum and reversal patterns exist both at style level and security level and style investing plays an important role in the predictability of returns. Barberis and Shleifer present a model where investors allocate funds based on the relative performance of investment styles which explains style momentum: "if an asset performed well last period, there is a good chance that the outperformance was due to the asset’s being a member of a “hot” style...If so, the style is likely to keep attracting inflows from switchers next period, making it likely that the asset itself also does well next period”. Style investing can also lead to mispricing when a security is re-classified such as when a stock is added to the
S&P 500 The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
index, its co-movement with the index increases while its co-movement with stocks outside of the index declines and possibly hurting performance.


Classification

When classifying
securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any fo ...
into styles, investors group together assets that appear to be similar, in the sense that they have a common characteristic. A characteristic can be an obvious one such as the country in which the security is traded, or the industry in which the firm operates. Other characteristics used as the basis for a style are based on size, risk, valuation, price return, or profitability.
Value investing Value investing is an investment paradigm that involves buying securities that appear underpriced by some form of fundamental analysis. The various forms of value investing derive from the investment philosophy first taught by Benjamin Graham ...
is well-known and emerged as a distinctive equity style following the work of Graham and Dodd (1934). Styles are sometimes also referred to as asset classes. Styles enable
institutional investors An institutional investor is an entity which pools money to purchase securities, real property, and other investment assets or originate loans. Institutional investors include commercial banks, central banks, credit unions, government-linked co ...
to organize and simplify their portfolio allocation decisions, as well as to measure and evaluate the performance of professional managers relative to standardized style benchmarks. The implications of style investing could have impact on financial markets, making stocks move together. Stocks can split stocks into categories of small-cap, mid-cap, large-cap, value,
defensive Defense or defence may refer to: Tactical, martial, and political acts or groups * Defense (military), forces primarily intended for warfare * Civil defense, the organizing of civilians to deal with emergencies or enemy attacks * Defense indus ...
, cyclical, growth, international, regional, technology stocks, utility stocks,
old economy Old Economy Village is a historic settlement in Ambridge, Beaver County, Pennsylvania, United States. Administered by the Pennsylvania Historical and Museum Commission, it lies on the banks of the Ohio River and is surrounded by downtown Ambrid ...
or new economy, disruptive innovation, and so on. Classification of securities into categories is widespread in
financial markets A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial markets ...
. Bonds are split into
high-yield bonds In finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade by credit rating agencies. These bonds have a higher risk of default or other adverse credit events ...
and investment grade bonds and short-duration and long-duration bonds. Traders classify assets as liquid securities such as
private equity In the field of finance, the term private equity (PE) refers to investment funds, usually limited partnerships (LP), which buy and restructure financially weak companies that produce goods and provide services. A private-equity fund is both a typ ...
and public equity. They may also do the same with illiquid securities, such as private debt, illiquid hedge funds, direct real estate and
venture capital Venture capital (often abbreviated as VC) is a form of private equity financing that is provided by venture capital firms or funds to start-up company, startups, early-stage, and emerging companies that have been deemed to have high growth poten ...
.


Financial industry

Financial firms
Lipper Thomson Reuters Lipper (part of Thomson Reuters) is an American financial services firm. Founded in 1973 as Lipper Analytical Services, it was acquired by Reuters in 1998. Corporate history Lipper Analytical Services was founded in 1973 by secur ...
and Morningstar developed and refined categorization systems and Style Box tools to aid with classification in the 1970s and 1990s. Also major index providers such as MSCI and FTSE offer a wide range of style-based indices. Also many asset managers offer style-based active strategies, sometimes also referred to as factor investing.


See also

* Low-volatility investing * Sector rotation * Size premium *
Value investing Value investing is an investment paradigm that involves buying securities that appear underpriced by some form of fundamental analysis. The various forms of value investing derive from the investment philosophy first taught by Benjamin Graham ...


References


External links


Style Investing: YaleStyle Investing: Evidence from Mutual Fund FlowsStyle Investing: Merrill LynchStyle Investing: HarvardStyle Investing, Comovement and Return Predictability
{{stock market Investment Financial economics