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The suitable investment style

May 20, 2021

reading time: 5 minutes

by Wilson Cheung, Investment Strategist and Stefan Hofer, Chief Investment Strategist (LGT Private Banking Asia)

Style Investing - finding investments with perspective

In times of change, do you have to question common assumptions, including investment styles? We take a look at the various possibilities facing investors.

The struggle between “remaining invested” and market timing

Perhaps one of the most often repeated maxims in financial markets is that equities reward patient investors: those who can hold on for the longer term. For example, had an investor placed USD 100 into a basket of globally diversified stocks in 1995, the returns as per the end of April 2021 would be +367% - taking the MSCI All Countries USD index as a benchmark. 

Put differently, over this very long period, the average monthly return for global stocks was 0.6%. The best month produced gains of +12.4% whereas the worst monthly loss was -30%. The range between these highs and lows is clearly significant, which is arguably why some observers remark that it is "hard to time the market". 

Active investing versus overemphasis on timing

An overemphasis on trying to pin point the best moment to enter or exit the market could result in material losses, but holding over the longer term smooths out these hills and troughs. In other words, the longer the holding period, the more likely an investor is to earn at least the average return.

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That said, many investors might not be content with using "time" as their driving investment strategy. To beat the longer-term average return, so-called "active bets" need to be made.

Alternatives for active selection: regional or per sector?

As such, the natural course is to make regional and/or sector bets, not just holding the widest, most generic basket of stocks in your portfolio.

In our view, the four traditional, most commonly invested regions are US, Eurozone, Emerging Markets and Japan. If we consider returns in common currency terms (taking the US dollar as an example), then over the above mentioned period of 1995 to April 2021, US stocks delivered the highest average monthly return of +0.8%. Europe and Japan come in second at +0.6% and Emerging Markets (in USD terms) come in third at 0.2%. What is perhaps more interesting is to consider the range of monthly returns across these four regions.

The monthly range is calculated by taking the best performing market less the worst performing market. Over the long run, the average monthly range of returns in 6.6%. This implies that on any given month, a strong bet on the winning market would result in a performance that is well above the average – which in turn is what so called active investment managers seek to do (and charge fees for).

The eleven sectors in financial markets

MSCI and Standard & Poor's have developed the Global Industry Classification Standard (GICS) to classify publicly traded companies. The GICS sorts the global industry using eleven sectors, including energy, materials, industrials, consumer discretionary, consumer staples, health care, financials, information technology, communication services, utilities and real estate. For investors, this classification helps balance or focus their portfolio.

More information can be found at MSCI (GICS).

Turning to global sectors, the potential for outperformance is even greater. Taking the standard global eleven sectors' performance, the average monthly range of performance is +9%. This suggests that the scope of beating the market average is higher in active sector selection as opposed to region or market selection alone. By definition, however, the downside risks are also significantly higher.

Traditional investment approaches: value vs. growth

Another common maxim in financial markets is that individuals should "invest in what they know". By doing your homework on the economic cycle, fiscal and monetary policy, companies, sectors and markets, investors may develop an affinity or sense of confidence in making active bets in the market. They may also form an overarching philosophy to investing; famous examples Value versus Growth investing. The former focuses on seeking out investments that are arguably cheaply valued against their balance sheet of profitability fundamentals. The latter advocates for focuses on future earnings growth potential, placing less emphasis on current valuation metrics.

Both approaches have been leading styles in the investment world. Depending on the reviewed time period, one investment style outperforms the other. In consequence, many investors choose a blend of both styles for their portfolios or rotate between the two depending on market conditions.

Integrating dividends in your strategy

What we currently see in the market is a renaissance on the dividend-style of investing. Indeed, as the below chart, over the longer term, dividends play an important part in investors' total returns. In part, this is because companies overall are reinstating or increasing their dividend payouts following a global rebound in profitability.

Standard & Poors 500 vs. Total Return Index vs. Dividend Aristocrats

The US investment bank JP Morgan estimates that in 2020 alone in Europe, 236 companies in the EuroStoxx600 index cut their dividends. Now that the economic recovery in Advanced Economies is accelerating, it stands to reason that investors are paying attention to dividend growth stocks, as many of those companies will again be in a position to reward shareholders with these payments. The future will tell how many of these companies can afford or want to reward their shareholders in this way again.

Dividend Aristocrats: "Cash Cows" for investors with a focus on dividends?

Indeed, there is an interesting variation on dividend investing: this is known as Dividend Aristocrats. These are companies that consistently increased their dividend payouts over the past 25 years, and as the same chart demonstrates; their long-term performance is compelling.

At LGT, we are strong advocates of investing in firms that have the capacity and intention to grow these payouts. In 2020, however, investors have seen drastic dividend cuts in most markets and regions, but especially in Europe. With the significant increase in cash flow, more and more companies can afford paying dividends again. We therefore anticipate that this style stays in vogue during the current economic recovery.

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