is an investment approach in which rotation
among different "styles" is supposed to be important for successful investing. As opposed to investing in individual securities, style investors can decide to make portfolio allocation decisions by placing their money in broad categories of assets, such as "large-cap", "growth", "international", or "emerging markets
Style investing is of interest to economists because it serves as a useful framework for identifying anomalous
price movements in stocks, such as those observed when a stock is added or removed from the S&P 500 index.
Style investing is the study of asset prices in an economy where some investors classify risky assets into different styles and move funds back and forth between these styles depending on their relative performance.
The fundamental basis for this trading method comes from classification
: the grouping of objects into categories. “Categorization simplifies our thinking, and enables us to process vast amounts of information reasonably efficiently. Mullainathan (2000) provides an innovative analysis of the implications of categorization for decision making.”
Classification of large numbers of stocks into categories is widespread in financial markets
. Traders classify assets as liquid securities such as stocks and bonds. They may also do the same with illiquid securities, such as real estate and venture capital
. Stocks may be classified as domestic or international, small or large, growth or value, “old economy
" or “new economy", cyclical
or non-cyclical. Such groups of securities are often called “asset classes
" or “styles”. Portfolio allocation based on selection among styles rather than among individual securities is known as “style investing."
The focus on styles enables institutional investors to organize and simplify their portfolio allocation decisions, as well as to measure and evaluate the performance of professional managers relative to standardized style benchmarks.
Investors often allocate
funds at the level of asset categories. The implications of this action in financial markets results in category-based investing, making stocks move together.
The investment problem faced by traders when they allocate our money across individual stocks is complex. They need a method to split their wealth across the thousands of different stocks out there. Investors often make decisions at the level of asset categories. They can split stocks into categories of small-cap, mid-cap, large-cap, value, growth, technology stocks, utility stocks, and so on, and then allocate their money across these different categories. Investment categories are sometimes called “styles”.