The divergence in performance between growth and value stocks over the past decade has become so wide that some commentators believe this is now systemic. In their view, the market has permanently bifurcated.
If this is the case, should growth and value in fact now be seen as different asset classes? Are their characteristics so different that they cannot be evaluated in the same way?
We asked four local fund selectors to give their views on this question. Their answers were as interesting as they were different.
Tawanda Mushore – Head of research at Seed Investments
It is not necessary to separate growth and value stocks as perceived asset classes, rather than viewing equity as a single asset class. Growth and value exist as different styles of equity investing.
Equity investments require a long-term horizon, patience, and an understanding of the merits of the investment. One can favour a particular investment style, but these characteristics still apply.
Performance between the styles is cyclical, and both value and growth can go through periods of under-performance. It is not beneficial to blindly assume growth or value will out-perform based on history. It is more important to understand the long-term drivers of future returns, and there is potential for one or both styles to benefit.
The protracted value under-performance and its magnitude makes it easy to have recency bias. Analysis over longer periods shows that, historically, value has out-performed more frequently.
In fact, 90 years’ worth of data from renowned academics Fama and French show predominantly value out-performance for most 10-year rolling periods used, with the exception of the Great Depression (1929 – 1939/40), the dotcom bubble (1989 – 1999) and the most recent period, which is also the longest (2004 – 2020).
This does not necessarily mean that things will revert to norm, but rather highlights the influence of recency bias. Value was also once untouchable, with long term data to back that view. However, things can change. Hence the need for patience and understanding performance drivers.
Technology-related businesses, for example, have been growing earnings and may continue to do so under current conditions. In value, bargains are available, which can drive future returns.
Not every stock whose price has been knocked down is a value opportunity, however. The investment thesis needs to be tested and retested to reap the long-term benefits for patient investors.
We favour quality growth companies in the current economic environment. Value is, however, an area we are watching closely, although we would not rush in.
We continue to look at equities as a single asset class but within that, identify areas of the market offering the most value. This is not based on price alone, but rather potential future returns.
Peter Foster – CIO at Fundhouse
Seeing equities as a single asset class is a convenient perspective, however it’s quite rare to come across a fund manager who thinks like this. Most often they are making security-level decisions, and seeking out opportunities which best align with their investment approach. Evaluating equity decisions at the index level, without considering what is inside, can be a significant cost to investors.
Individual equities fall into a spectrum across many different dimensions: cheap or expensive, high growth or low growth, developed markets or emerging markets for example. At any point in time you will have winners and losers. The trick is to find the temporary losers (e.g. ‘value shares’) and the permanent winners (e.g. ‘growth shares’ or even ‘quality shares’). There are also other ways to invest which can lead to market-beating performance.
Each of these opportunities requires a very different mindset to support an investment case. Most often this means that the investment approach, organisational structure and even the culture needs to be aligned with each approach in order to be successfully managed.
The important point here is that both approaches – value and growth investing – can add value over time. In the current environment, we have seen quite distinct share price performance between value and growth type shares.
While there are likely elements of this disparity which are temporary in nature, it is also likely that part of the difference is explained by real world outcomes and differences in prospects between companies. It is rarely a black-and-white answer.
Separating how we allocate to these approaches is useful to investors, as they have a broader pool of investment opportunities over which to diversify their risk. This provides a more consistent investment outcome over time.
Jan-Daniël Klopper – Investment analyst at Mentenova
‘Diversification is the only free lunch in investing’, is the quote attributed to the Nobel laureate Harry Markowitz.
We know that no one investment style consistently out-performs all other styles. To illustrate this we looked at the performance of four style indices we created and ranked their annual performance for each year since 1996:
Investment manager style diversification is a form of diversification that is often overlooked during the portfolio construction process, as it is tempting to try and pick the investment style that will out-perform other investment styles in future. History has however taught us that it is extremely difficult to forecast financial markets.
By making use of a diversified blend of investment styles we are recognising that we don’t know what the future holds. Superior returns might be produced by any one of the investment styles, and we would like exposure to that style either through skilled active managers or smart beta solutions.
In the absence of style diversification, a portfolio may have:
• A highly correlated manager return profile.
• The possibility of extended periods of under-performance when a particular style is out of favour.
• A bulky alpha return profile that is not suited to most investors.
Considering the outcome of the above analysis, one would fall short by attributing equity market returns to only growth or value. It would make sense to broaden the lens one uses when assessing equity market returns, and by doing so acknowledging the underlying heterogeneous characteristics of the equity market.
The work by Fama and French forms the bedrock of factor investing. Their landmark research, published in 1993, evidenced that value outperformed growth from 1963 to 1991.
When they increased the sample to span to cover 1963 to 2019, they did find that the value factor performed weaker relative to growth from 1991 to 2019 than the initial findings. However, after comparing the two periods, they do not come close to rejecting the hypothesis that out-of-sample expected premiums are the same as in-sample expected premiums.
This contradicts the notion that growth and value are becoming divergent asset classes.
The above emphasises the need for a diversified portfolio, exposed to various style factors. This will increase the probability of an uncorrelated return profile, decrease the probability of extended under-performance due to particular style being out of favour, and a smoother alpha profile.
Nadir Thokan – Portfolio manager at Corion Capital
With a cumulative performance of 278% for growth over the last decade and just 87% for value, it is clear that all equity globally cannot be viewed as a homogeneous asset class. Even a level of simplistic differentiation just purely on price-to-book has become somewhat necessary.
This year has exacerbated the trend, in that growth has out-performed value by almost 50% year to date. Most of this out-performance has been generated during the strong global equity rally of the last two quarters.
US equities now trade at more than a 40% premium relative to their 30-year average multiple. The strong equity market rally during the last two quarters (and by default the performance of racy growth stocks) was driven primarily by multiple expansion as opposed to earnings growth or increasing dividends, with value being left behind.
A metric often used to determine how attractive value is relative to growth is the multiple differential between the cheapest and most expensive component of the equity market. Should this differential be very wide, there should be a significant amount of alpha to be harvested by allocating capital to a value orientated strategy.
- Multiple discrepancies between the cheapest and most expensive third of the market are at the highest levels they’ve been at in 50 years.
- Even when excluding highly rated technology shares from the analysis the differential is still historically wide.
It is clear that an allocation to a value-orientated strategy is materially different from that into a growth orientated strategy. This is notwithstanding the fact that both are picking instruments within the same notional asset class.
Investors should spend a great deal of time focusing on the stocks within the value segment of the market that are actually inappropriately valued and offer good free cash generation prospects over a suitable time horizon, and are not just value traps.
Patrick Cairns is South Africa Editor at Citywire, which provides insight and information for professional investors globally.
This article was first published on Citywire South Africa here, and republished with permission.