Equity Investment Strategy: Do You Need One?

Equity investment strategies are essential for optimising returns and managing risks. They are a set of principles that guide your portfolio decisions and help you make smarter choices about where to put your money. Before choosing a strategy, it's crucial to assess your financial situation, risk tolerance, and investment goals.

There are two broad approaches to active equity investment strategies: fundamental and quantitative. Fundamental strategies emphasise the use of human judgment in processing information and decision-making, while quantitative strategies rely more heavily on rules-based quantitative models.

Various types of equity investment strategies exist, including value investing, growth investing, dividend investing, momentum trading, sector rotation, and passive index investing. Each strategy has its own characteristics, risk profiles, and investment criteria, so investors must conduct comprehensive research to understand their intricacies.

Additionally, when considering equity investment strategies, it's important to remember the risks involved. Market risks, credit risks, foreign currency risks, liquidity risks, political risks, economic concentration risks, and inflation risks can all impact equity investments.

By choosing the right equity investment strategy, investors can enhance their financial well-being, achieve their financial goals, and manage their risk exposure.

Active vs. passive equity investing

Equity investment is money that is invested in a company by purchasing shares of that company in the stock market. These shares are typically traded on a stock exchange. Equity investors purchase shares of a company with the expectation that they will rise in value in the form of capital gains and/or generate capital dividends.

There are two main types of equity investment strategies: active and passive.

Active investing involves a fund manager picking and choosing investments, whereas passive investing typically tracks an existing group of investments called an index. Passive investing strategies tend to perform better than active strategies and are more cost-effective.

Active investors research and closely follow companies, buying and selling stocks based on their view of the future. This approach is more suitable for professionals or those who can devote a lot of time to research and trading. Active investing requires a hands-on approach and is more expensive due to higher fund management fees, trading fees, and taxable events. It also tends to be more risky but offers the potential for higher returns.

Passive investors, on the other hand, buy a basket of stocks and buy or sell regularly, regardless of how the market is performing. This approach requires a long-term mindset and the ability to disregard the market's daily fluctuations. Passive investing is often considered a more suitable strategy for beginners as it offers diversified exposure, lower fees, and lower risk compared to active investing.

Both active and passive investing strategies have their advantages and disadvantages, and the best approach depends on an individual's financial goals, risk tolerance, and level of expertise. Some investors even choose to blend the two strategies to take advantage of the strengths of both.

Advantages of equity funds

Equity funds offer investors a diversified investment option, allowing them to spread their risk across various instruments and companies. Here are some advantages of equity funds:

Expert Management

Equity funds are managed and monitored by experts with extensive knowledge of mutual funds and markets. These fund managers analyse market trends and make adjustments to the funds to leverage favourable conditions and minimise risk. Their expertise helps investors navigate the complex world of investing and potentially optimise their returns.

Tax Benefits

In certain jurisdictions, equity funds offer tax advantages. For example, in India, the Equity Linked Savings Scheme (ELSS) provides tax benefits under the Income Tax Act, allowing investors to reduce their tax liability.

High Returns Potential

Equity funds primarily invest in company stocks, which represent ownership and a claim on the company's profits and losses. This direct link to a company's performance means that equity funds have a high potential for returns, often outpacing the market average.

Convenience and Affordability

Equity funds offer flexible investment options. Investors can choose between lump-sum investments or instalment plans like Systematic Investment Plans (SIPs). SIPs are particularly beneficial for those who receive a monthly salary and prefer to invest smaller amounts regularly. The affordability of equity funds, with low minimum investment requirements, makes them accessible to a wide range of investors.

Liquidity

Equity funds also offer high liquidity, allowing investors to quickly access their money. Redemption amounts are typically credited to bank accounts within a few days, providing investors with the assurance of quick access to their funds when needed.

In summary, equity funds provide expert management, tax benefits, high returns potential, convenience, affordability, and liquidity. These advantages make equity funds an attractive option for investors seeking to diversify their portfolios and maximise their investment returns.

Equity investment risks

Market Risk: Stocks are susceptible to market forces, and their values can fluctuate based on various factors such as company performance, industry trends, and economic conditions. As a result, investors may lose some or all of their investment if the stock value declines.

Credit Risk: This risk arises when a company is unable to pay its debts. It can lead to financial losses for investors if the company fails to meet its financial obligations.

Foreign Currency Risk: Changes in the value of different international currencies can impact a company's worth. Currency fluctuations can affect a company's revenue, especially if they have significant operations or sales in multiple countries.

Liquidity Risk: Liquidity risk pertains to a company's ability to meet its short-term debt obligations. If a company faces liquidity issues, it may struggle to repay its debts, potentially affecting investors' returns.

Political Risk: Political changes or instability in a country can impact a company's performance. Unfavourable policy changes, regulatory shifts, or political turmoil could lead to reduced returns or losses for investors.

Economic Concentration Risk: This risk arises when a company's value is heavily concentrated in a single entity, sector, or country. If the performance of that entity, sector, or country declines, the company's value could drop disproportionately.

Inflation Risk: Rising inflation can negatively impact a company's value and dilute its worth. Inflation can erode the purchasing power of consumers, affecting the company's sales and profitability.

Additionally, in the context of private equity investments, there are a few specific risks to consider:

High Investment Minimums: Private equity investments often require substantial minimum investment amounts, which can magnify both gains and losses.

Long Holding Periods: Private equity investors typically need to commit their funds for several years. This lack of liquidity can be a concern for investors who may need to access their funds in the short term.

Unproven Companies: Private equity firms often invest in new companies or startups with high growth potential but no proven track record. This lack of established performance increases the risk of losses if the companies fail to live up to expectations.

Management and Operational Risks: Private equity firms often replace the existing management team and make operational changes to improve the companies they invest in. However, these changes may not always yield positive results, potentially leading to losses for investors.

Overall, understanding and carefully evaluating these equity investment risks are crucial for making informed investment decisions and constructing a robust investment strategy.

Long/short equity strategies

Long/short equity managers purchase equities they anticipate will increase in value (long positions in undervalued companies) and sell equities they believe will decline in value (short positions in overvalued companies). The primary objective is to remain adaptable in identifying attractive opportunities on both sides of the market and effectively allocate them within a portfolio.

There are several types of long/short strategies:

• Sector-specific: Focus on a particular sector or industry, such as banking, technology, or pharmaceuticals.
• Geographic: Invest in specific markets or regions, such as the US, Europe, or emerging markets.
• Market neutral: Employ strategies to minimise the fund's sensitivity to outside market volatility.
• Portfolio diversification: Long/short strategies provide the potential for a more diversified portfolio that is less correlated with equity and fixed-income markets.
• Excess returns: By relying less on upward markets, long/short strategies can generate returns from both rising and falling prices.
• Risk management: The ability to profit from short positions during bear markets provides a hedge against market downturns.

However, it's important to consider the risks associated with long/short strategies, including higher trading costs, complex investment strategies, and the potential for significant losses.

The implementation of long/short equity strategies involves several steps:

• Defining the universe of stocks: Identify a universe of stocks based on factors such as dollar volume, market capitalisation, price, and impact costs.
• Bucketing stocks: Group the stocks based on sectors or industries.
• Defining parameters for long or short positions: Rank the stocks within each bucket based on performance and use this ranking to determine long or short positions.
• Capital allocation: Allocate capital across the selected stocks, considering approaches such as equal-weighting or market capitalisation-based weighting.

Choosing a financial advisor

Equity investment is money that is invested in a company by purchasing shares of that company in the stock market. These shares are typically traded on a stock exchange. The main benefit of equity investment is the possibility of increasing the value of the principal amount invested, which comes in the form of capital gains and dividends.

When it comes to choosing a financial advisor, there are several steps you can take to ensure you find the right one for your needs:

Identify your financial needs

First, reflect on what you hope to get out of the relationship with your financial advisor. Do you need help with personal finance, debt management, investing, tax strategy and planning, retirement, or estate planning? Knowing what type of assistance you require will help you find an advisor who can provide specialised guidance in that area.

Know what credentials to look for

Financial advisors go by many names, and anyone can legally call themselves a financial advisor. Hence, it is crucial to verify their specific credentials. Look for designations such as Chartered Financial Analyst (CFA) or Certified Financial Planner (CFP), which require holders to act as fiduciaries, prioritising their clients' interests. You can verify an advisor's credentials on the CFA Institute's or CFP Board's website.

Review financial advisor service types

There are several types of financial advisors to choose from, including robo-advisors, online financial advisors, and traditional financial advisors. Robo-advisors are digital services that provide simplified, low-cost investment management based on algorithms. Online financial advisors offer virtual access to human advisors and are a good middle ground between robo-advisors and traditional advisors. Traditional financial advisors meet with clients in person and often provide the highest level of service, but at a higher cost.

Evaluate how much you can afford to pay a financial advisor

Financial advisors' fees vary, so it's important to understand their cost structure before committing. Robo-advisors typically charge lower fees, while traditional advisors may charge a flat fee or a percentage of the assets they manage for you. Online financial advisors may charge a flat subscription fee, a percentage of your assets, or both.

Vet the financial advisor's background

Always research a financial advisor's background and verify their credentials and experience. Check their Form ADV and review their employment record and any disciplinary actions on FINRA's BrokerCheck website.

Hire the financial advisor

Once you've found a suitable advisor, the next step is to start engaging their services. This typically involves an initial consultation, followed by the advisor providing legal documents and gathering information about your financial situation.

Key Questions to Ask a Potential Financial Advisor:

• Are you a fiduciary committed to acting in my best interest?
• How do you make money?
• Do you always act as a fiduciary, even when selling commission-based products?
• What is your approach to financial planning?
• What financial planning services do you offer, and do they align with my needs?
• What kind of clients do you typically work with, and do you have experience with clients similar to me?
• Do you have any account minimums or other requirements that match my financial situation?
• Do you have any conflicts of interest in managing my money?
• What information do you need from me to develop my financial plan?
• How often will we meet, and what is your communication policy?
• Will you collaborate with my other advisors, such as CPAs or attorneys?

Frequently asked questions