Investment strategy

An investment strategy is a set of rules, behaviors or procedures, designed to guide an investor's selection of an investment portfolio.

In the most general sense, investment strategy starts with decisions about asset allocation, as part as an investment policy statement (IPS) or investment plan that considers your objectives, time horizon, tolerance for risk, etc. These aspects are covered in other articles. Here we assume that an IPS and asset allocation have been established and the investor is deciding how to manage investments within specific asset classes.

Different investing strategies can be adopted, and will suit different investors, depending a number of factors, such as tolerance for risk, investing knowledge and experience, time available for portfolio management, temperament, etc. Strategies can be broadly classified as passive versus active, although some strategies do not fit neatly into these categories. Passive strategies are often used to minimize transaction costs and accept the return of an investment benchmark, while active strategies make specific investments with the goal of outperforming an investment benchmark index, reducing risk, or creating more income.

This article attempts to summarize a number of strategies to give you some background and ideas that might be helpful for you to determine what might be good strategy or strategies for you to follow. A number of the strategies are specific to equities. Fixed income specific strategies such as laddering, barbell, bullet and immunization are beyond the scope of this article.

Strategy vs. style
In investing, the terms strategy and style are not generally well defined and sometimes (often?) used interchangeably (e.g., by the Globe and Mail ).

In some definitions, investing strategy can include asset allocation and risk management, but here we assume that the investor already has a financial plan, has chosen an an asset allocation, and is now deciding on how to manage each asset class within the portfolio.

For the purposes of this article, investment style refers to different style characteristics of equities, bonds or financial derivatives. For example, the investment style of a mutual fund or index fund helps set expectations for long-term performance potential and aids in advertising the fund to investors looking for a specific type of market exposure. Many mutual fund investors may be familiar with the Morningstar Style Box system.

Choosing a strategy
So how should you choose an investing strategy? It comes down to personal fit.

Passive investing
Passive investing (also called passive management) is a strategy in which an investor (or a fund manager) invests in accordance with a pre-determined strategy that doesn't entail any forecasting (e.g., any use of market timing or stock picking would not qualify as passive management). The idea is to minimize investing fees and to avoid the adverse consequences of failing to correctly anticipate the future. The most popular and time-tested passive strategy is called indexing.

Active management
Active management attempts to outperform the market, lower the risk of a portfolio, or increase its yield, using various techniques.

In its traditional form, the active manager is given free rein to manage a mutual fund, exchange-traded fund or other pool of assets in whichever way he or she likes, within a given asset class. The equivalent for individual investors is stock picking (building a portfolio of individual stocks). Of course, active managers use certain strategies, such as those described below, but they are not necessarily rules-based. Canadian mutual funds with active management have a hard time beating their benchmarks over five years. This is largely due to high costs.

A currently fashionable rules-based form of active management is called "smart beta".

"Smart" beta
A more passive form of active management is the so called smart beta strategies. ETFs based on such strategies follow pre-determined rules, and often follow alternative (i.e. not cap-weighted) indexes. According to the Financial Times, "Smart beta refers to an investment style where the manager passively follows an index designed to take advantage of perceived systematic biases or inefficiencies in the market. It therefore costs less than active management, since there is less day-to-day decision-making for the manager, but since it will, at the very least, have higher trading costs than traditional passive management (which minimises those costs), it is a pricier option."

Depending on the definitions, smart beta or ‘strategic-beta’ strategies can include fundamentally weighted indices, equal weighted indexes, value, growth and dividend-oriented funds, and low-volatility strategies. Therefore "smart beta" can be seen a marketing term. William Sharpe says that smart beta makes him “definitionally sick” and that "if smart beta is really only exploiting others’ stupidity, the anomalies it exploits will be eliminated over time".

At the end of 2019, after several years of strong inflows, 'factor' ETFs had a 12% market share among equity ETFs in Canada, while "dividend/income" ETFs had 13%, compared with 59% for cap-weighted ETFs.

Issues with smart beta strategies include:
 * the factors are back-tested, but some factors may not deliver in the future
 * constructing factor portfolios in academic research is very different from how smart beta ETFs work or perform
 * additional costs (higher MERs, higher turnover, etc.) may overwhelm any actual out-performance relative to a broad market cap-weighted index
 * performance chasing: investors may choose these strategies based on recent performance
 * factors may under-perform over long periods, which could lead to behavioral issues (not being patient enough to actually capture the premiums)

Strategies
Many investors like to draw a clear distinction between passive vs. active management, but strategies don't necessarily fit into this classification, and many equity management strategies can be implemented as using either passive or active management.

An investor may choose to implement their investment policy statement (IPS) or investment plan and asset allocation with a portfolio that uses one or more of the following equity management strategies. A combination approach if often used for investments in different asset classes, for example active management of Canadian equities and passively managing other asset classes.

The following strategies are presented in alphabetical order.

Beating the TSX
Beating the TSX is a Canadianized version of the 'Dogs of the Dow' strategy. It is based on choosing the ten highest-yielding stocks in the S&P/TSX 60 index, excluding former income trusts, and reconstituting the portfolio once a year. There is no need to conduct detailed research on each company.

Buy and hold
One of the better-known investment strategies is buy and hold. Buy and hold is a long term investment strategy, based on the concept that in the long run equity markets give a good rate of return despite periods of volatility or decline. A purely passive variant of this strategy is indexing, where an investor buys a small proportion of all the shares in a broad-based market index such as the S&P/TSX Composite (Canada) or S&P 500 (US), or more likely, in a mutual fund called an index fund or an exchange-traded fund (ETF).

This viewpoint also holds that market timing, that one can enter the market on the lows and sell on the highs, does not work or does not work for small investors, so it is better to simply buy and hold.

Contrarian investing
Contrarian investing involves going against the crowd to exploit perceived mispricings in stock markets.

Dividend growth investing
Dividend growth investing is an active management strategy that focuses on stocks with a long history of dividend increases. The objective is to produce a steadily increasing income stream that is immune to market fluctuations.

Dollar cost averaging
Dollar cost averaging (DCA) is the method of buying a fixed dollar amount of a particular investment such as equities on a regular schedule, regardless of the share price.

Dollar value averaging
Value averaging uses mathematical formula to control the amount of money invested in a portfolio over time. It uses spreadsheets to determine how much to allocate to various asset classes, so that their value increase every month up to a scheduled amount.

ESG portfolio screening
Some investors wish to screen their portfolios based on Environmental, Social, and Corporate Governance (ESG) criteria.

Growth investing
Growth investing is an investment approach that focuses on stocks with above average growth.

Indexing
The efficient market hypothesis (EMH) is one of the factors that leads one to indexing. Put simply, since you can't beat the market, you attempt to passively replicate market performance. It involves the use of broad-based index funds and index-based exchange-traded fund (ETFs). Turnover is normally low which improves the tax efficiency.

Another argument for indexing is Bogle's cost matters hypothesis: Because index funds and ETFs have the lowest costs, they beat most other funds or strategies.

Ways to implement indexing in a Canadian context are listed under Portfolio design and construction.

Low beta investing
Low beta investing (also called "Low-Volatility Investing") involves investment in stocks that have lower volatility than the market in an attempt to get higher returns.

Momentum investing
Momentum investing is an investment approach that focuses on stocks with large increases or decreases in price. It assumes that the price trend will continue. Basically, it says buy when the price is increasing and sell when the price is decreasing.

Multifactor investing
Multifactor investing attempts to tilt a portfolio towards value stocks and small cap stocks, in the hope of achieving a higher return than with a total stock market approach.

Value investing
Value investing involves buying stocks at undervalued price based on some fundamental measure such as high dividend yield, low price-to-book value, or low price-earnings ratio.