A Guide to Investment Style

Transcription

1 A Guide to Investment Style Another Layer of Diversification

2 Complete diversification is at the heart of smart investing and investment style is an integral part of achieving it. Here s how investment style fits into the world of diversification: Investors understand that different mutual funds perform well at different parts of the economic cycle and each is subject to some volatility. A small-cap fund, for example, might do well while a large-cap fund staggers. Ideally, an investor would like to hold each when it performs well and not when it struggles but that s not realistic history has shown that timing the market is virtually impossible. So investors diversify their portfolio by selecting Canadian large-cap and small-cap equity funds, bond funds plus foreign content from the U.S. and around the globe to spread their risk and exposure to any single industry, country or asset class. Slow returns from one part of the portfolio are compensated for by strong returns from another. The result is a portfolio of funds with smoother returns that suits an investor s risk tolerance and needs. This is where investment style fits by adding the final layer of risk management. The reason is illustrated in the chart (opposite page) that shows how four distinct investment styles perform over the long run. 2

3 The black line indicates the progress of the S&P TSXComposite Index, while the coloured boxes show the top performing investment style in each month over a five and a half year period. Specifically, the graph shows us that: The VALUE style is in favour at market bottoms The GROWTH style is in favour when markets start to improve The GARP (Growth At a Reasonable Price) style outperforms during flat markets The DEEP VALUE style is in favour when the market peaks and starts to fall Any one style, while it does have its strengths, misses much of the picture. And similarly, an investor missing one of these styles misses an element of complete diversification. In fact, research has shown that a one-style portfolio is exposed to 53% more risk than a blended-style portfolio*. Keeping returns high while minimizing risk might seem like an impossible dream, but that is exactly what you re striving to achieve by choosing a mix of investing styles. COMPARISON OF STYLE PERFORMANCE 12,000 10,000 8,000 6,000 DEEP VALUE VALUE GARP GROWTH J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J Source: Globe HySales as of July 31, 2004 * Rolling 3 year track record for the Templeton International Equity Trust, Fiduciary EAFE Composite and a combination of both over the MCSI Index. There isn t any single winning investment style. HARRY MARMER Senior Vice President Franklin Templeton Institutional 3

4 Measuring Diversification Selecting the right funds for a diversified portfolio can be a time consuming and imperfect science. And the consequences of the wrong mix can have serious consequences for a portfolio and an investor. A portfolio with a high concentration in growth stocks, for example, could leave a portfolio too volatile while too few growth stocks may yield sluggish returns. One way of measuring the diversification of a portfolio is by measuring fund correlation. Ideally each of the funds should have a lower correlation to that of the next fund. Do they react to economic news in the same way? Do they react to market news in the same way? If they do, it s more than likely they shouldn t be in the same portfolio. Fund correlation is measured by a coefficient number between -1.0 and 1.0. A higher number indicates that the funds will react similarly to market changes and economic news, which ideally, an investor wants to avoid. For example, the table below shows how Franklin Templeton Balanced Growth Portfolio part of Franklin Templeton Investments Quotential Program fits together. The low coefficients between the 13 funds in Franklin Templeton Balanced Growth Portfolio means that together, each of these funds is performing a different function in the portfolio at a different point of the economic cycle. 3 YEAR DEGREE OF CORRELATION 1 1 Bissett Bond Class A 2 Bissett Canadian Equity Class A 3 Bissett Income Class A 4 Bissett Small Cap Class A 5 Franklin U.S. Large Cap Growth 6 Franklin U.S. Small-Mid Cap Growth 7 Mutual Beacon 8 Templeton Canadian Stock 9 Templeton Emerging Markets 10 Templeton Global Bond 11 Templeton Global Smaller Companies 12 Templeton Growth High 0.70 to 1.00 Moderate 0.11 to 0.69 None to 0.10 Moderate Negative to Highly Negative to Copyright 2004 Morningstar Research Inc. 4

5 The aim is always the same: to provide the investor with a simple solution: a package of funds diversified by asset class, geographic region, market capitalization and investment style that suits the investor s goals. In the past, to achieve the right formula, investors and advisors were faced with the task of mixing and matching funds, and cross-referencing for fund correlation. Today, managed programs like the Quotential Program do the work for investors, by putting it all together in one package. FRANKLIN TEMPLETON S INVESTMENT STYLES Franklin Templeton Investments believes in offering investors the benefits of diversification, including management style. That s why it offers mutual funds in four distinct but complementary styles under one roof each with a longterm track record of investment success. value growth GARP deep value 5

6 Value Templeton has a 50-year track record for contrarian, bottom-up value investing. Templeton buys at the point of maximum pessimism and sells at the point of highest optimism; this philosophy is based on disciplined fundamental analysis. THE PROCESS Together, 55 Templeton portfolio managers and analysts globally conduct original research from 17 offices worldwide, studying stocks in 40 countries. They re looking for bargains, and they start by conducting quantitative analysis to identify companies that are undervalued relative to normalized five-year earnings expectations. The cheapest 20% of a short list of roughly 1,000 companies move on to the next phase of analysis. Then the fundamental analysis begins. Sector and country specialists examine qualitative factors, conducting well over 1,500 company visits each year to meet with management. Does the management understand the outlook and competitive developments in its industry? How do they treat minority shareholders? Templeton analysts look at the financial health of the company, examining its balance sheet. Profit margins must be high enough to pay down debt and cover expenses while at the same time paying for research and providing growth opportunities. Once a business has met Templeton s high quantitative and qualitative standards the entire research group must approve of it at meetings held twice weekly. If the company passes this final test, it is added to the "Bargain List" and is approved for purchase by any Templeton fund. A valuation target is immediately assigned to the stock, defining the price at which it should be sold. The average equity security will be held for five years. UP CLOSE: VALUE STOCK PICKING Templeton s purchase in 2002 of Reuters Inc., one of the biggest data vendors and suppliers in the world, is a classic value stock pick. The company appeared on Templeton s bargain list as the global economy and Reuter s chief clients in the financial services industry were under duress. It was making fewer sales, but additionally Reuters was competing against Bloomberg, a private company in the same business, particularly in the past couple of years. Templeton s contrarian position on the stock led them to make further analysis, which revealed that although Reuters had lost some market share, they still controlled the lion s share of the foreign exchange market, an important and profitable business line. Furthermore, Templeton knew from experience that Reuters had a competitive product that it could improve upon while it restructured its business operations. The company s stock price was depressed and recovered well for Templeton. You re not contrarian because you want to be, but you re always a little incredulous about prevailing conventional wisdom. 6 GEORGE MORGAN Lead Manager, Templeton Growth Fund

7 Growth Franklin Advisers, Inc. has more than 30 years of growth management experience and benefits from the strategic location of its headquarters, near the technology and biotechnology heartland, Silicon Valley. 45 portfolio managers and analysts work together to uncover potential investments in an exceptional breadth of industries. THE PROCESS Franklin hunts for companies that are growing faster than the overall economy. The team s top-down approach is attracted to industry leaders with competitive advantages that help to increase their market share. Often the sector in which these companies operate benefits from an economic or demographic trend that drives consumer growth. When selecting companies in which to invest Franklin portfolio managers want to see strong balance sheets, income statements and cash flow statements that demonstrate financial strength and profitability. They examine historical returns on equity and top-line growth. They determine how sustainable margins look going forward given the company s management team, corporate strategies, products and technologies. They consider risk factors, including debt levels, competitive pressures and foreign currency exposure. Specialist sector teams keep buy, sell and hold ratings and target prices on all the stocks they cover, and they share their top picks with all the Franklin portfolio managers and analysts in daily meetings. UP CLOSE: GROWTH STOCK PICKING Franklin added pet healthcare provider VCA Antech to Franklin Flex Cap Growth Fund during the company s initial public offering in November An IPO is not always an ideal time to make an investment, but VCA fit Franklin s criteria. First, pet care is a relatively new industry whose growth outstrips that of the overall U.S. economy. The sector is driven by a consumer trend. Pet owners are paying for more and more expensive medical procedures when their pets are injured or become ill. Furthermore, there is little financial risk involved in the procedures. But just as important, VCA s management showed Franklin that it was able to deliver on financial goals in the past and by Franklin s analysis there was plenty more room for growth for the company. VCA had made back office and lab investments that will allow it to achieve economies of scale as the pet health-care industry continues to grow. Compared to a lot of our competitors we have a broader and deeper research staff we re a very fundamental bottom-up shop and we pride ourselves on knowing all the companies in the various industries. ED JAMIESON Chief Investment Officer, Portfolio Manager, Franklin Equity Group 7

8 GARP Since 1982, Bissett Investment Management has consistently followed a rigorous bottom-up investment style called Growth at a Reasonable Price (GARP). This style gives an investor a less volatile ride compared to pure growth investing. It consistently produces superior risk adjusted returns. THE PROCESS A multi-disciplinary team of portfolio managers and analysts scan hundreds of stocks monthly. They use computer models that rank companies on growth criteria including return on equity, earnings growth, revenue growth and dividend growth as well as value characteristics, such as price-to-earnings, price-to-sales and price-to-book ratios, and dividend yield. Any company in the top 25% is a potential new investment for Bissett. The second step is fundamental analysis of companies that made the quantitative cut. The team looks for evidence of strong, stable, experienced management and conducts an in-depth examination of the environment in which a business operates, evaluating industry growth prospects and a company s competitive position. Each portfolio must adhere to the GARP principle. Target weightings are established for each holding and monitored regularly and rebalanced depending on how the stock is performing. Several times a year a stock may be sold because fundamentals, like its earnings outlook, is deteriorating but more often because its share price has grown quickly and valuation multiples are excessive. UP CLOSE: GARP INVESTING Power Financial is a classic example of a company attractive to Bissett s GARP investment style. This is a company in the financial services industry whose price-to-earning multiple will never reach into the hundreds, like the P/E s of some growth stocks. Power Financial is the holding company for Great West Life, one of the biggest insurers in the country, and IGM, the biggest mutual fund company in Canada. Canadians buy financial products irrespective of the economic cycle. New sales will fluctuate but management fees, generated by assets under administration, will continue to drive Power Financial s earnings in any economic background. Bissett takes positions in stocks with some price stability, which it can own for four to five years subject to trimming when a stock price is unreasonable or if its weighting in each of Bissett s portfolios is too high. Power Financial fits the bill because it has a track record of consistent earnings, revenue and dividend growth but its stock price is not likely to reach a speculative level. Another factor Bissett considers is return on equity, a measurement of a company s profitability. A high return on equity indicates a good business, and Power Financial s return on equity is in the high teens. We want companies that exhibit good, predictable, replicable growth characteristics. However it s also very important that you don t overpay for its stock. 8 MIKE QUINN President and Chief Investment Officer, Bissett Investment Management

9 Deep Value Investing With a history of more than 50 years, Mutual Series has developed a unique approach to investing focused on reducing downside risk by investing in undervalued companies that are in special situations. Careful research can uncover deep value in companies involved in mergers or acquisitions, those in distress, or even those in bankruptcy. Mutual Series expertise in these situations helps its management assess opportunities and identify select investment opportunities. THE PROCESS The Mutual Series team of nearly 20 portfolio managers and analysts looks for struggling or unrecognized businesses around the world, but especially in Canada, the United States and Western Europe. Mutual Series digs deep into a company s financial statements, the nature of its business and what motivates the company s management. This in-depth research reveals companies trading at bargain prices based on their intrinsic value today. To earn a place in a Mutual Series fund, a business must also have a solid balance sheet and a management team motivated to unlock shareholder value. The team buys assets at cents on the dollar, and sells when the assets have reached full value. Mutual Series will take a role in helping a management realize the company s full value. Its analysts will share their expertise when they believe it s in the best interest of shareholders. That might mean identifying hidden inefficiencies or investigating catalysts with the potential to draw out a company s real value. Typical catalysts can include a change in management, a restructuring, or a specific change in a company s market conditions. Mutual Series knows how to value businesses and buy their securities at big discounts. A portfolio of these types of special situations has produced solid returns over time with less risk than would normally be associated with investing in distressed business or special situations. Mutual Series investments tend to be more affected by company specifics than broader shifts in the equity markets. UP CLOSE: DEEP VALUE INVESTING Consider Mutual Series investment in Telephone & Data Systems (TDS) as a typical example of its investment style. In mid-1995, its research concluded that the company, a telecommunications provider offering wireless, wireline, and local telephone services was deeply undervalued. TDS had significant growth opportunities that were largely unrecognized by the market in the telecommunications sector. In 1997, after building a substantial stock position, Mutual Series initiated a proxy fight for control of TDS and finally won 80% of shareholder votes. Mutual Series successfully elected an independent director to serve on TDS s board of directors. It was the catalyst that TDS needed to increase its focus on shareholder value. In 1999, the merger between TDS s subsidiary, Aerial Communication, and VoiceStream Wireless was announced. It was completed in 2000, strengthening TDS stock price and the value of Mutual Series holdings in the company. We know how to value businesses and buy their securities at big discounts. That s what we try to do. A portfolio of companies in special situations has produced solid returns over time with less risk. DAVID WINTERS President and Chief Investment Officer, Mutual Series 9

10 Any one style, while it has its strengths, misses much of the picture. Similarly, if any one of these four styles is missing from a portfolio, an important element of the market is lost. Together, these four investment styles can be an integral part of investors success in achieving their goals. For more information on investment style and a simple solution to complete diversification, please contact your investment advisor or visit 10

11 The simplest way to diversify. Now you can get a simple, secure investment solution with unparalleled diversification. Diversified by asset class, investment style, geographic region and more, the Quotential Program offers you unmatched diversification. A world of diversification. One simple solution. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Franklin Templeton Investments prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

12 Founding Member of The Canadian Coalition for Good Governance. Franklin Templeton Investments Corp. 1 Adelaide Street East, Suite 2101, Toronto ON M5C 3B8 Client Services Toll-free: Fax: Sales Team Toll-free: Fax: TTY: NYSE: BEN LSE: FRK Canadian offices: V ANCOUVER EDMONTON CALGARY WINNIPEG T ORONTO OTTAWA MONTREAL HALIFAX The indicated rates of return are historical annual compounded total returns including changes in share/unit value and reinvestment of all dividends/distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Franklin Templeton Investments prospectus before investing. Mutual fund securities are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the money market funds will be able to maintain their net asset value per security at a constant amount (the money market tax class funds will not maintain their net asset value per security at a constant amount) or that the full amount of your investment in the Fund(s) will be returned to you. Share/unit values change frequently and past performance may not be repeated. 1717ADVDIE(1004)