It is a common misconception that a good equity fund manager should outperform the market every single year. In reality, equity investing is cyclical, and performance depends significantly on investment style, market conditions, and macroeconomic phases.

 

Investment Philosophy: The Foundation of Every Strategy

Every equity fund manager follows a defined philosophy—value, growth, quality, momentum, large-cap bias, mid-cap bias, or thematic exposure. Each style has periods when it performs strongly and phases when it inevitably underperforms. Understanding this fundamental truth is essential for investors seeking to evaluate fund performance fairly and make informed decisions about their portfolios.

The investment philosophy chosen by a fund manager is not arbitrary—it reflects their deep-seated beliefs about how markets function, what drives long-term returns, and how to identify opportunities. This philosophy becomes the lens through which they view every investment decision, guiding security selection, portfolio construction, and risk management.

Importantly, a well-defined investment philosophy provides discipline during challenging periods. When a particular style falls out of favour, it can be tempting to abandon the approach. However, managers who maintain consistency in their philosophy are often better positioned to capture returns when their style comes back into favour.

 

Value Investing: Patience Rewarded in Recovery Phases

 

Market Recoveries

Value-oriented managers tend to excel during market recoveries when undervalued securities regain their true worth. As investor sentiment improves and fundamentals reassert themselves, companies trading below intrinsic value often experience significant price appreciation.

Rising Interest Rate Environments

When interest rates rise, the present value of distant future cash flows decreases, making growth stocks less attractive. Value stocks, often with near-term cash flows and stable dividends, become relatively more appealing to investors seeking current returns.

Valuation-Conscious Markets

During periods when market participants focus on traditional valuation metrics like price-to-earnings ratios and book values, value strategies shine. These phases typically follow periods of exuberance where valuations became stretched.

Value investing requires patience and conviction, as these managers may underperform during momentum-driven markets or periods of abundant liquidity. However, over complete market cycles, disciplined value approaches have historically delivered competitive returns whilst managing downside risk.

 

Growth and Quality Strategies: Different Cycles, Different Winners

Growth-Focused Managers

Growth-focused managers usually outperform in liquidity-driven bull markets where long-term earnings visibility is rewarded. Investors become willing to pay premium valuations for companies demonstrating consistent revenue growth, market share gains, and scalable business models.

These strategies particularly excel when central banks maintain accommodative monetary policies, as lower discount rates make future earnings more valuable in present-value terms. Technology sectors and innovative businesses often lead during such periods

Quality-Focused Strategies

Quality-focused strategies perform better during volatile or uncertain phases but may lag during sharp risk-on rallies. Quality investors seek companies with strong balance sheets, consistent profitability, competitive advantages, and reliable cash flow generation.

During market turbulence, investors gravitate towards these characteristics, seeking safety and predictability. However, when risk appetite surges, higher-beta stocks often outperform these stable, defensive holdings.

The cyclical nature of market leadership between growth and quality highlights why diversification across investment styles can be valuable. What underperforms today may lead tomorrow as market conditions evolve.

 

Expansion Phase Performance

During economic expansions, smaller companies benefit from increased consumer spending, easier access to capital, and the ability to grow revenues more rapidly than established corporations. Their nimbleness allows them to capitalise on emerging opportunities quickly.

Liquidity Sensitivity

Small and mid-cap stocks are particularly sensitive to liquidity conditions. When credit is readily available and investor risk appetite is high, these stocks attract significant capital flows. Conversely, during periods of monetary tightening, they often face disproportionate selling pressure.

Risk-Off Underperformance

When market sentiment turns cautious, investors typically rotate towards large-cap, liquid stocks with established track records. This “flight to quality” can lead to extended periods of underperformance for smaller capitalisation strategies.

 

Understanding Style Rotation and Market Leadership

Market leadership itself is constantly changing—between sectors, market capitalisations, and investment themes. As a result, style rotation is unavoidable, and no single approach can outperform across all market cycles.

This rotation occurs because different economic conditions, monetary policies, and investor sentiment favour different types of companies. What works brilliantly in one environment may struggle in another, not due to poor management but due to the natural ebb and flow of market dynamics.

Sector leadership also shifts cyclically. Defensive sectors like utilities and consumer staples lead during economic uncertainty, whilst cyclical sectors such as industrials and materials outperform during expansions. Technology may dominate during innovation-driven periods, whilst financials benefit from rising interest rates.

Recognising this constant evolution helps investors maintain realistic expectations and avoid making emotional decisions based on short-term underperformance. The key is identifying whether a manager is underperforming due to style headwinds or due to poor stock selection within their stated approach.

 

Evaluating Fund Managers: Process Over Short-Term Returns

Understand the Investment Philosophy

Before investing, thoroughly understand the manager’s stated investment philosophy and approach. This provides the framework for evaluating whether subsequent performance aligns with expectations and market conditions.

Align With Your Profile

Match the manager’s investment style with your own risk profile and time horizon. A growth-oriented fund may be unsuitable for conservative investors seeking income and capital preservation.

Maintain Diversification

Diversification across investment styles helps smooth returns across market cycles. Holding value, growth, and quality-oriented funds provides exposure to different market leadership periods.

Evaluate Full Cycles

Assess performance over complete market cycles, not calendar years. A three-to-five-year period typically captures enough variation in market conditions to fairly evaluate a manager’s skill.

Short-term underperformance should not automatically be viewed as poor fund management. Often, it reflects discipline—sticking to the stated process rather than chasing momentum. In contrast, managers who frequently change styles to protect near-term performance may compromise long-term outcomes and create style drift that undermines portfolio construction.

 

The Path to Long-Term Wealth Creation

In equity investing, consistency of process matters more than consistency of annual returns. Long-term wealth creation comes not from avoiding periods of underperformance, but from staying invested with disciplined managers through inevitable market cycles.

Investors who understand this principle are better equipped to maintain their investment discipline during challenging periods. They recognise that a value manager underperforming during a growth-led rally is not necessarily failing—they are simply experiencing the natural headwinds of their style being out of favour.

The most successful investors develop patience and perspective. They resist the temptation to abandon managers during temporary underperformance and avoid chasing recent top performers whose style may be nearing exhaustion. Instead, they maintain diversified exposure across styles and rebalance periodically to take advantage of style rotation.

Stay Disciplined

Maintain investment discipline through market cycles

Think Long-Term

Focus on multi-year outcomes, not quarterly results

Trust the Process

Value consistent methodology over short-term performance

Ultimately, successful equity investing requires aligning expectations with reality. By understanding that no manager can outperform every year, investors can make more rational decisions, maintain appropriate diversification, and achieve superior long-term outcomes. The objective is not to find the perfect manager, but to build a robust portfolio that performs across various market environments.