There are many strategies for "beating the market". "Bottom-up"
strategies focus on the valuations of individual securities and ignore changes
in market valuations and the economy. "Top-down" strategies involve
changing the commitment to various market segments within asset classes. "Technical
Analysis" and other quantitative strategies focus exclusively on the
historical patterns of price and return movements, independent of other factors.
Security Selection and "Bottom-Up" Strategies
Classic "value" and "growth" investors focus almost
exclusively on security selection. They believe that it is impossible to catch
swings in market sentiment and spend their time analyzing and buying good
securities. They believe that good security selection will overpower the "noise"
of market movements in the longer term.
Sector Rotation
"Top-down" or "sector rotation" strategies focus on
changing the allocation of equity or bond portfolios depending on the outlook
for each sector, based on "big picture" economic, political and
business factors. Rather than assess individual securities, the sector rotator
tries to catch major changes in "macro" variables i.e. the growth rate
of the economy.
An equity manager might emphasize the "cyclical stocks," those
stocks that show large changes in earnings because of the economic cycle (early
in an economic recovery). As the recovery progressed, the large earning
increases of these cyclical stocks would be recognized by the market, and their
stock prices would increase. A bond manager would lower the term of his bond
portfolio if higher interest rates were expected. In a poor economy, with weak
corporate profits, a bond manager would lower the portfolio exposure to
corporate bonds, as their credit worthiness would deteriorate. An equity manager
expecting higher interest rates might sell utility and bank stocks, as the price
of these "income stocks" are heavily influenced by the movements of
interest rates.
Technical and Quantitative Strategies
Technical Analysis and quantitative techniques focus exclusively on the
patterns of price and return movements of individual securities, sectors, and
even asset classes. A portfolio manager using technical analysis might decide to
sell a stock solely upon its recent price movements, independent of the
fundamental outlook for the stock. This extends to markets as well, the "asset
allocation" specialist would perhaps lower the equity weight in a portfolio
to zero, based upon quantitative relationships compared to historical norms. |