Value vs. Growth vs. Index Portfolios
By Kevin Slater
We have traditionally had a value bias in the equity portion of portfolios. Value stocks have uncharacteristically underperformed growth stocks over the past ten years leading to a great debate of whether “things are different”. Our response is to reduce but not eliminate our value bias by increasing our allocations to neutral market cap weighted indexes.
Long-Term History of Value Investing
SoundView has long held a “value-bias” in our portfolios, which is to say, our equity portfolios tend to hold more investments with a relatively lower Price to Book Ratio (aka value). Our reasoning goes back to research work originally done by Eugene Fama and Ken French at the University of Chicago which revealed that value-oriented investing has historically outperformed growth-oriented and therefore market capital weighted (neutral) index investing over extended periods of time.
While in any given year growth may outperform value, more often than not value outperforms growth. Value’s outperformance becomes more notable over longer periods of time.
Short-Term History of Value Investing
Unfortunately, we are experiencing a period in which growth has outperformed value eight out of the last eleven years. As a result, our value bias has had a negative effect on client portfolios rather than a positive benefit. Looking back at history, the only other times this has occurred were during the Depression and in the late 1990s. In both of those circumstances growth outperformed with a vengeance.
This has led to a great debate within SoundView’s Investment Committee and among portfolio managers across the country. Have things changed or is this just an abnormality which will soon/eventually “revert to the mean”?
The Future of Value Investing
There are some who believe Price to Book is no longer a relevant benchmark given the nature of companies in the 21st century. Our economy is dominated by service and technology companies, not manufacturing firms. The best firms now spend far more on research and development than on inventory for example—substantially altering how they might score on this metric.
Additionally, we have seen a great inflow into value factor based funds. As with any strategy, the more money that flows into it, the lower the returns one can expect going forward.
On the other hand, some would say that the earnings of the underlying companies, whether value or growth, have generally been proportionate to each other except in extreme circumstances such as the Tech Bubble and the Credit Crisis. And like in those periods, we have seen a great divergence over the past eighteen months.
Fama/French US Value Research Index provided by Fama/French from CRSP securities data. Includes the lower 30% in price to book of NYSE securities (plus NYSE Amex equivalents since July 1962 and Nasdaq equivalents since 1973).
Fama/French US Growth Research Index provided by Fama/French from CRSP securities data. Includes the higher 30% in price to book of NYSE securities (plus NYSE Amex equivalents since July 1962 and Nasdaq equivalents since 1973).
The Russell 1000 Growth Index is compromised of large and mid cap US equities that show characteristics of growth including higher price to book ratios and higher forecasted growth.
The Russell 1000 Value Index is compromised of large and mid cap US equities that show characteristics of value including lower price to book ratios.