McGraw-Hill

230 Managing Portfolios
have concentrated on finding stocks selling at prices perceived be t
low relative to the company’s assets or earnings. Growth managers
have sought stocks with above-average earnings growth not fully
reflected in price. Small-capitalization managers have looked for
opportunity in stocks that have been overlooked by most investo
The establishment of benchmark indexes based on growth, value,
and small-cap segments of the market has encouraged this type of
claims-staking.
While such style preferences and other forces act to segment
the equity market, however, other forces to integrate act it. After all,
some managers select their portfolios from the broad universe of
stocks, and others may focus on a particular of stock type given current
economic conditions, but are poised to change their focus
should underlying conditions change. The capital of these investors
flows across style segments, integrating the overall market.
Most importantly, all stocks can be defined by the same funda-
.mental parameters-by market capitalization, price/earnings ratio,
dividend discount model ranking, and so on. All stocks can be
found at some level on the continuum of values for each parameter.
Furthermore, their positions are not static; an out-of-favor growth
stock may slip into value territory or a small-cap company may
grow into the large-cap range. Arbitrage works toward market i
gration. If too many investors want low P/E, for example, low-P/E
stocks will be bid up to higher P/E levels. Some investors will sell
them and buy other stocks deserving of higher P/Es.
The tenuous balance between integration and segmentation is
one aspect of the market’s complexity. We find that this dimension
of complexity is best captured by viewing the broadest possible
range of stocks through a wide-angle analytical lens. This does not
mean that we ignore the very real differences in price behavior th
distinguish particular market subsets, or that we cannot choose to
focus on a particular subset. It simply means that the model used fo
analyzing individual stocks incorporates all the information available
from a broad universe of stocks.
This approach offers a coherent framework for analysis that
may be lacking in more segment-oriented approaches. Consider, f
example, a firm that runs one model on its total universe of, say,
3000 stocks and then runs a different, segment-specific model on a
500-stock subset of large-cap value stocks. What if the total-