Explore How Fund Managers Select Stocks Using Fundamental and Macroeconomic Analysis to Build Strong Investment Portfolios.

The selection of stocks is a complicated process which requires proper access to the markets. Experts and experienced fund managers often handle this process of stock selection. They try strategies like qualitative and quantitative analysis, along with top-down and bottom-up investing approaches, to select the correct stock. Further, this blog lets us understand in detail the fund managers stock selection process.

What Are The Steps Involved in Stock Selection by Fund Managers

A fund manager selects stocks based on different factors depending on the situation. They analyse various aspects before shortlisting the companies to invest. Further, let us look at the process of fund managers’ approach to picking stocks:

1.Understanding Funds Objective

Before selecting the stocks, the fund manager tries to understand the fund’s investment objective. Every fund is created with a specific aim, whether it is money appreciation, stable wealth creation or a balance of both.

• Growth funds: They track the companies with higher growth potential for revenue and earnings
• Value funds: These funds track undervalued stocks which are trading at a lesser price compared to their intrinsic value.
• Income funds: These are the funds that focus on dividend-paying stocks to generate stable cash flow.

2.Fundamental Analysis

Fundamental analysis is one of the crucial criteria for stock selection by fund managers. Fund managers extensively use this to analyse the company’s financial health, business, competitors, and growth scope. Key metrics  in fundamental analysis include:

a) Financial statement analysis.

Fund managers look at a company’s income statement, balance sheet, and cash flow statement to get their profit data, debt data, and liquidity. Key metrics include:

• Revenue and Earnings Growth: Regular growth in revenue and earnings is a good sign.
• EBITDA and Profit Margins: High or improving margins show that the company is efficiently running its business.
• Debt-to-Equity Ratio: A low ratio shows that the company is not very dependent on debt.
• Free Cash Flow: Positive cash flow allows a company to reinvest in its business or return money to shareholders.

b) Valuation Metrics

Fund managers consider valuation ratios to check whether a stock is over or undervalued. Common metrics include:

• Price-to-Earnings (P/E) Ratio: It compares a company’s current market price to its earnings per share.
• Price-to-Book (P/B) Ratio: It measures the price of stock to its book value.
• Enterprise Value-to-EBITDA (EV/EBITDA): It evaluates a company’s value relative to its earnings before interest, taxes, depreciation, and amortization.

Fund Manager analysing quality stocks

3.Macroeconomic Analysis

Another key investment strategy used by fund managers is macroeconomic analysis. Fund managers don’t just analyse individual companies, but they also consider the broader macroeconomic analysis. This involves:

• Interest Rates: Rising interest rates may affect growth stocks but have a positive impact on their financials.
• Inflation: High inflation may lead to a fall in the profit margins due to rising cost of raw materials. However, value stocks which are the companies already trading below their intrinsic value, often perform better during inflationary periods.
• Economic Growth: A robust economy usually enhances corporate earnings, whereas a recession can cause declines.

4.Portfolio Framing

Once fund managers choose potential stocks, they need to decide how to diversify the capital amongst each stock. This includes:

• Diversification: To reduce risk, managers of funds invest in various industries, nations, and asset classes. This serves to avoid being overly dependent on a single stock or market.
• Position Sizing: Managers determine how much to put into each stock depending on the risk level, anticipated profit, and whether it is in line with other stocks in the portfolio.
• Rebalancing: Portfolios are rebalanced periodically in order to maintain the proper proportions of assets. It involves the selling of investments that have appreciated significantly and purchasing those underpriced ones.

Fund manager and research team managing portfolios

Role of Fund Manager

The fund manager is the most important part of any investment fund and helps make it successful. Their job is not just to choose stocks,  they also plan strategies, study the market, manage risks, and share information. Here is a closer look at what a fund manager does:

• Research: The primary work of a fund manager is research. They spend considerable time observing companies, industries, and market trends in hopes of making the best investments. They study financial statements, read industry reports, and monitor market news. Fund managers must have a thorough knowledge of the companies they are investing in and how they are organized, what makes them successful, and how they can expand. This research enables them to make sound investment decisions.
• Portfolio Formation: Once the potential stocks are selected, the fund manager determines the amount invested. They consider risk, return, and how the stocks will relate to one another. The goal is to create a balanced mix of investments suitable to the fund’s purposes and lower risk.
• Managing Risk: Handling risk is a part of a fund manager’s job. They make sure the fund is not too concentrated on a single stock, sector, or market. To do this, they diversify in various areas and use options like stop-loss orders or hedging to prevent portfolios from big losses. They also track the fund’s risk and make changes accordingly.
• Monitor Performance: It is a part of a fund manager’s work. They ensure the fund is not excessively exposed to a single stock, sector, or market. They do this by diversifying investments in different sectors and employing devices such as stop-loss orders or hedging to shield portfolios from significant loss. They monitor the risk of the fund and make the necessary changes.
• Communication with stakeholders: Fund managers play an important role in conveying financial strategies and plans to investors, analysts, and other stakeholders. They inform them of the progress, why an investment was made, and calm their fears. Effective communication is central to trust-building and maintaining the confidence of investors.

Risk management by the fund management team.

Conclusion

Stock analysis techniques used by fund managers is a tricky process that requires a synergy of abilities, industry knowledge, and strategy. Fund managers use tools and strategies to construct portfolios that achieve the goals. Ultimately, fundamentally strong stock selection companies with good fundamentals, sustainable competitive advantages, and the capacity to create long-term value for investors.