Fusion investing
A strategy that combines fundamental analysis with behavioural finance: screen for value, filter for financial strength, then pick the stocks showing strong price momentum.
In plain language
Fundamental investors say a stock's price is the discounted value of its future cash flows. Yet prices swing sharply in the short term for reasons that have little to do with cash flows — they reflect the collective behaviour of investors and traders.
Fusion investing tries to use both facts. It integrates traditional and behavioural paradigms, combining fundamental analysis with behavioural finance.
The workbook uses Benjamin Graham's line: "in the short run the market is a voting machine, and in the long run it is a weighing machine." Fusion investing integrates both the voting and the weighing machine — the value-growth phenomenon from fundamental investing and the momentum effect from behavioural finance.
How it works
Three screening steps (Chapter 14, section 14.4):
| Step | Filter | Measures the workbook names |
|---|---|---|
| I | Value — from the universe of stocks | P/E, P/BV, P/S |
| II | Fundamental strength — historical and forecast | profitability, leverage, efficiency (e.g. Piotroski score) |
| III | Momentum | price uptrend |
Stocks left after Step III qualify for the portfolio.
The Piotroski score (workbook footnote): a discrete score from 0 to 9 reflecting nine criteria of a firm's financial strength; 9 is best, 0 is worst; named after accounting professor Joseph Piotroski.
The workbook's cautions:
- Intuitively it seems a good strategy, but market data is insufficient to conclusively prove it.
- Momentum is short-term, so the portfolio needs rebalancing much more often than the value-growth screens would need.
- So transaction costs play a critical role in the overall return, and taxation must also be considered in rebalancing.
A worked example
Illustrative figures. A PMS manager runs a fusion screen on a universe of 200 listed stocks for a ₹50 crore strategy.
| Step | Screen | Stocks left |
|---|---|---|
| I | P/E and P/BV below the universe median | 60 |
| II | Piotroski score of 7 or more | 22 |
| III | Price above its 200-day average and rising | 15 |
The 15 survivors are held in equal weights: ₹50 crore ÷ 15 ≈ ₹3.33 crore each.
The catch the workbook warns about: momentum fades quickly. Suppose the manager re-runs Step III every month and replaces 4 of the 15 stocks each time. That is 4 × ₹3.33 crore ≈ ₹13.3 crore sold and bought monthly — about 27% of the portfolio. At an illustrative round-trip cost of 0.5%, that is roughly ₹6.7 lakh a month, or ₹80 lakh a year — about 1.6% of ₹50 crore, before any capital gains tax on the short-term profits. The value-growth steps alone would not require anything like that turnover.
Why NISM asks about it
Chapter 14 (Behavioural Finance), section 14.4, describes fusion investing, Graham's voting-and-weighing-machine quotation, the three steps and the cautions on evidence, rebalancing, transaction costs and tax. Chapter 18 (Equity Portfolio Management Strategies) covers the value screens (section 18.8.2) and momentum investing (section 18.7) that the strategy combines.
Common exam traps
- Order of steps: value → fundamental strength → momentum. Swapping the order is an easy trap.
- Momentum comes from behavioural finance; value-growth from fundamental investing.
- Piotroski score runs 0 to 9, with 9 best. It is a Step II tool, not a momentum measure.
- The workbook does not claim it is proven. It says market data is insufficient to conclusively prove it.
- Short-term momentum means frequent rebalancing — so transaction costs and tax are critical, not incidental.
Where this is taught
- Series XXI-B · Chapter 14: Behavioural Financeintroduced here
- Series X-B · Chapter 16: Basics of Behavioral Financeintroduced here
Related terms
- Fundamental analysisEstimating what a share is worth from the profits and cash flows the business will generate, then buying only when the market price sits below that estimate.
- Behavioural financeThe study of how psychology shapes the decisions of market participants, individually and in groups, and how those decisions show up as gaps and anomalies in financial markets.
- Piotroski scoreA discrete score from 0 to 9, built from nine criteria on a company's financial statements, used to filter for financially strong value stocks — nine is the best score, zero the worst.
- Value AnomalyThe finding that stocks with a high book value-to-price ratio have earned superior risk-adjusted returns — an anomaly against the EMH that underpins value investing.
- Momentum investingAn active strategy that rides an ongoing price trend — long in a rising trend, short in a falling one — worked from price and volume data rather than a company's fundamentals.