For a truly diversified portfolio, don’t ignore investing styles
Your mutual funds may be diversified across asset classes and market cap, but many investors ignore a crucial third layer – diversifying across investing styles such as growth, value, and factor investing. This can protect your portfolio during downturns and supercharge it during bull runs.
Diversification in mutual funds is usually discussed in terms of asset classes (equity, debt, gold, etc) or market capitalisation. What’s often ignored is diversification across investment styles – growth, value, and factor investing, to name a few.
Growth investing tends to do well when the economy is expanding and confidence is high. Fund managers who employ this style back companies that reinvest aggressively to expand, and tend to grow earnings faster than their peers. These stocks often trade at premium valuations because investors are willing to pay more today for the promise of faster earnings growth in future. However, this style of investing is not without its challenges. When growth expectations falter even slightly, richly valued stocks can plummet as optimism unwinds.
Value investing works differently. It tends to do well when there is an economic recovery following a period of uncertainty. The focus is on businesses trading below their intrinsic worth, often because of temporary challenges. As conditions stabilise, these stocks tend to rebound, delivering steady, sometimes outsized returns. The post-2008 recovery and the initial months after the covid shock were periods when value investing did better. But value investors must also endure long stretches of underperformance until their stocks are back in favour.
Flexi caps for the win
For investors looking to blend styles, flexi cap funds are a natural starting point. With the freedom to invest across market capitalisations and sectors, fund managers in this category can express their investment philosophy clearly. Some flexi cap funds lean decisively towards growth, backing companies with strong earnings visibility and leadership potential. Others tilt towards value, focusing on reasonable valuations and a margin of safety. Holding funds with contrasting approaches can help smooth portfolio returns across market cycles.
Understanding a fund’s style requires digging deeper. The fund house’s overall philosophy can play a role here, as some consistently follow a defined approach, but individual fund managers can also stamp their signature on their portfolios.
Deepak Chhabria, chief executive officer and director of Axiom Financial Services, said, “Investors can gauge a fund’s investment style by reading the fund manager’s media interactions and closely tracking the portfolio to see whether the stated philosophy is actually reflected in stock selection,"
Investors should also be wary of ‘style drift’, especially when growth investing morphs into momentum chasing.
Value-conscious mid- & small-cap funds
A bias for growth bias is common in mid- and small-cap funds as these managers typically look for companies that can scale rapidly and eventually graduate to large-cap status. Still, value-conscious options exist even here, offering a more disciplined approach to risk.
Value-oriented small-cap funds can act as a critical hedge against exuberance. They adopt a contrarian or "deep value" approach, searching for overlooked businesses or turnaround stories trading significantly below their intrinsic worth.
Factor funds cut out the bias
Beyond traditional funds, factor-based strategies add another layer of style diversification. Instead of betting on a manager’s "gut feel" about a company's future, these strategies target specific risk premiums or market anomalies like quality (profitable companies with low debt), momentum (stocks on an upward trend), or low volatility.
By automating the selection process based on these quantifiable characteristics, factor funds eliminate human emotional bias and provide a transparent, lower-cost alternative to active management that can thrive even when traditional stock-picking falters.
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