Fund Training: Relative vs. Absolute

Written by admin on April 8th, 2011

If you are interested in learning more about advisory investing, it will prove beneficial to take some annuity courses. One highlighted course is value investing, which is a strategic approach to choosing stocks that trade for less than their inherent values. However, there are different ways in which managers choose to approach the topic and there is no right or wrong technique, as it is all a matter of preference.

There is much to learn when it comes to fund training because there is no universal definition to value investing. How a manager defines value will determine what is in the portfolio and, ultimately, the fund’s performance. The two major types of value investing are relative-value and absolute-value. A relative-value investor compares a stock’s price ratios (e.g., P/E, P/B and price-to-sales) with a category benchmark and then makes a decision about the future prospects.

In general, relative-value funds have a decent shot of delivering strong performance in a variety of market conditions-not just when truly cheap stocks are in demand. The key drawback to the relative-value approach is that these funds might also have more exposure to volatile sectors, with technology and telecom being the prime examples.

The “absolute value” approach values the entire company, using things such as its assets, balance sheet, cash flow, and expected future earnings. Managers who practice the absolute value method will also look at what private investors have paid for similar companies. Absolute-value managers do not compare a stock’s price ratios to that company’s historic norms, those of other companies, or the market.

Whether the fund is relative-value or absolute-value based, the average price multiples of the portfolio will show if the manager is acquiring stocks that are more or less expensive than other offerings in the category. Average price multiples can be found in shareholder reports. Although value funds generally show less volatility than growth funds, this does not guarantee safety. In many previous market downturns, such as the cyclicals and financials decline of 1990, the utilities debacle of 1994, and the Asian crisis of summer 1998, value funds lost as much or more money than growth funds.

Value managers want to buy stocks that are viewed as cheap or inexpensive, relative to the corporation’s current valuation or by some other measurement. Growth managers interest lies in a company’s earnings, revenues, and/or the potential for the stock’s price to appreciate. A growth manager is usually not expecting any kind of bargain. The companies they seek have higher P/E and P/B ratios than their value peers.

Most growth fund managers are earnings-driven; this means that the corporation’s earnings are used as the main measurement for growth. Fund training will most likely focus around the idea of earnings and growth potential. Within the earnings-driven camp are “momentum” managers who are considered the most aggressive of their peer group. You might say their mantra is “Buy high, sell higher.” Momentum investors buy rapidly growing companies they believe are capable of delivering an earning’s “surprise,” such as higher-than-expected profits or other favorable news that will drive the stock’s price higher.

A momentum-driven manager tries to buy a stock just before its positive earnings announcement; these same managers hope to sell the same stock just before it misses analyst estimates or before a release of bad news. This type of discipline tends to have very large turnover rates and price multiples that are high or ultra-high. Momentum managers care little, if any, about a stock’s current price.

If you are going to buy a momentum fund, make sure you can stomach significant downturns. Following a disciplined dollar-cost averaging strategy is one way to smooth out some of the bumps that come with the momentum territory plus helps to avoid jumping in and bailing out at exactly the wrong times.

The different ways in which investments can be structured provide individuals the flexibility to construct fund portfolio that will best meet their needs. Although this provided a basic knowledge of value investing, it would be a smart idea to enroll in additional annuity courses to build your skill and technique awareness.

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