The growth style outperformed the value style on a cumulative basis for the 14 years through 2020, leading some observers to wonder if value was dead (Exhibit 1). In late 2020, promising news about COVID-19 vaccines led to a significant rotation in the market toward companies that stand to benefit more as economies start to reopen. This rotation started off as a “value rally” but quickly morphed into a high-beta rally, leaving investors wondering what will happen in 2021 and what that will mean for investing.
We think the growth-versus-value debate needs to be reframed. Rather than growth versus value, we think in terms of growth and value — focusing not on short-term leadership but on capturing long-term opportunities and managing risks within each style.
Moreover, we believe major benchmarks might not be the best proxies for underlying investment-style performance. We think active managers with broad expertise and a disciplined process will be better positioned to capture the opportunities and manage the risks associated with both growth and value in the years ahead.
Seeking compelling stocks rather than timing the market
Growth’s long run may obscure the fact that on a cumulative basis it has been outperformed by value for the past 70 years, despite periodic stretches of growth leadership (see Exhibit 1). In our view, this history of rotation in style leadership should cause investors to pause and reflect before declaring value dead. We believe that both styles are in fact very much alive, but that the duration and magnitude of either style’s cycle is unknowable.
Rather than trying to time style leadership, we think it wiser to invest in both the growth and value universes, focusing on stocks that are positioned well to add value in the years to come. Our stock-by-stock research currently finds inflated valuations among individual stocks in both styles. One reason is that in 2020 the most expensive stocks outperformed the cheapest in both the value and growth categories. But we think this is unlikely to reoccur for any sustained period.
The “growth at any price” approach many investors have favored in recent years carries considerable risks, we believe. Historically, lower valuations have led to strong long-term returns while higher valuations have tended to preface weaker long-term returns (see Exhibit 2).
In both the value and growth universes, valuation is an important consideration as we look for stocks that we believe are poised to deliver robust future returns. We engage in spirited debates about appropriate valuations, with input from both equity and fixed income analysts across our global research platform.
The risks of investing based on style benchmarksAs stated above, it is no longer safe to assume the major benchmarks are suitable proxies for access to a style.
Over the past 10 years, concentration in growth indices has risen to historic highs. For example, the five largest stocks in the Russell 1000® Growth Index now constitute nearly 40% of that benchmark. As a result, investors accessing this style through index funds now face unprecedented concentration risk. If the Growth Index was a mutual fund, it would be labeled "nondiversified" under SEC rules.
The indices determine which stocks qualify as growth or value based primarily on price-to-book ratio, arguably an outdated metric. That method presents two potential problems. First, book value can be useful for valuing a company whose business depends primarily on its use of physical property such as farms, factories or shopping malls, but it does not adequately capture the value of intangible assets such as intellectual property and brand value, which are increasingly more important to many companies today. The second potential problem with relying on price-to-book is that is doesn’t account for certain important risks, such as the rise in leverage in pockets of the market.
A time for active management
A combination of fiscal and monetary stimulus, along with an appetite for growth at any price, helped lift the overall markets in recent years. Expanding valuations rather than improving earnings drove all the market gains of 2020.
We don’t believe those conditions will continue indefinitely. Investors will eventually return to the factors that have been historically been the most important drivers of returns: earnings and dividends. An active manager that performs deep research into company fundamentals may be best equipped to evaluate which companies can deliver long-term earnings growth and what will be needed in the way of dividends to create value for investors in the coming years.
Collaboration leads to better insights
In today’s complex world, successful analysis requires teams that look at the issues from a variety of perspectives, allowing them to better account for the ways factors — from technological disruption to regulation to financial market dynamics — might affect businesses and their share prices. Active managers leverage those broad perspectives to fully assess a company's prospects on a number of fundamental dimensions — growth, returns, valuation and sustainability. They also comprehensively assess risk, including concentration risk, in order to generate strong risk-adjusted returns over time.
We believe these types of analyses work best when analysts do not operate in silos. Our global research platform draws on many perspectives and takes into account a broad range of considerations, from business fundamentals to macroeconomics to environmental, social and governance (ESG) factors.
Every equity and fixed income analyst works on a sector team composed of peers who cover the same sector as them around the world. The analysts bring insights from their experiences living and working in their regions. They work closely with portfolio managers and their peers to fully explore their ideas, helping to develop a comprehensive, holistic view of the risks and opportunities facing each company. This process helps to eliminate biases related to style, region and asset class. We believe this collaboration gives us a differentiated view versus the broader market and leads to better investment decisions and outcomes.
And this, along with the reasons touched on above, is why we believe this type of active approach will help deliver strong risk-adjusted returns for our clients in both growth and value portfolios over the long term.
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