One of the first practical lessons in investing is that a well-constructed portfolio means one that is appropriately diversified. The standard form of diversification is through combining asset classes — such as bonds and property funds — with equities. However, this is not necessarily enough to reduce or optimize portfolio volatility. Diversification by management style is often the missing link in getting the right mix.

What exactly is investment style?

In this investment context, a style can be defined as the method that managers use to buy stocks or other assets. Newcomers to the investment business are often surprised at the very considerable variation and latitude in style and its powerful impact on performance at a given time and over a period of time. (For related reading, see Focus Pocus May Not Lead To Magical Returns .)

According to Shawn Menard, writing in the Canadian Investment Review (Risk Management: A Dynamic Process, 2000), this remains an underrated but extremely useful means of spreading risk. The deliberate use of variations in investment style as a means of reducing volatility is gaining considerable acceptance in the investment world; many believe that a symbiotic blending of management styles is an important part of the diversification process.

So-called style rotation has arguably become even more important in the new millennium, as the conventional equity-bond split has lost effectiveness through global capital market integration. Stylistic differences between money managers lead to a low correlation between or within asset classes that are managed with varied approaches. This is extremely valuable at a time when globalization tends to iron out differences between asset classes and many international markets are increasingly moving in tandem.

Offers and Guarantees of Style Diversification

Several investment advisory firms from around the world have developed plans to diversify their clients’ portfolios across asset classes, within asset classes and across investment management styles. In the same way that different asset classes perform better and worse at different times, so too do varying approaches to management within these asset classes.

Some major university endowment funds specify diversification in terms of style and guarantee to hire a certain number of managers with varying styles. The University of Missouri, for instance, promises a minimum of five separate managers, providing different and complementary strategies of equity investing. The objective is to ensure the absence of either under- or over-exposure to particular style approaches. (For more insight, read How do university endowments work? )

The Main Styles

Value and Growth

The two classic stock-picking styles are those of value and growth. The value style entails buying stocks that are regarded as cheap, whereas growth stocks are expected to grow faster than the rest of the market. These two basic methods are quite different and, by having funds with both styles, investors are able to enjoy the best of both worlds. Particularly over the longer term, investors are likely to find that volatility can be reduced by mixing investment styles. (For more on these styles, read Warren Buffett: How He Does It and Venturing Into Early-Stage Growth Stocks .)