Value vs. Growth: A Balancing Act
by Daniel B. Berkowitz
One of the more compelling trends that the investment management industry has been following closely over the last few years is the prolonged underperformance of the “value” investing style. This general underperformance has occurred over a long enough period that even some prominent investors are meticulously reexamining their beliefs and hypotheses about the strategy or in some cases exiting from the marketplace.
Value investing itself can be defined and executed in many different ways, though it generally refers to a strategy seeking to capture benefit by investing in “cheaper” securities relative to more “expensive” securities. A security’s level of “cheapness” or “expensiveness” is often assessed through one or more valuation metrics that link share price (for equities) to some fundamental measure of a company—for example, book value of equity (i.e., Price/Book) or earnings (i.e., Price/Earnings). The “growth” investing style, value’s counterpart, focuses on these more “expensive” companies which generally have better projected prospects for growing corporate earnings, amongst other criteria.
Historically, over long periods, the value strategy has tended to deliver a positive return premium. One study, for example, found that over the 84-year period commencing in July 1926 and ending in June 2010, the value return premium (over growth stocks) was an annualized 3.8%. The value investing strategy has been examined extensively in academic literature which makes it particularly important to PMA given our academic roots.
It is true that asset classes and investment strategies often cycle through periods of out- and -underperformance relative to each other. But the extent and duration of value’s more recent underperformance is notable, especially given the positive return premium value has tended to deliver historically. To provide a simple illustration of this performance pain, below are the last ten calendar year returns for the Russell 3000 Value and Growth Indexes. In seven of the ten years outlined below, the Russell 3000 Growth Index outperformed its value counterpart. (Note the particularly large disparity in 2020). Over this full period, the Russell 3000 Value Index returned an annualized 10.36% while the Russell 3000 Growth Index returned an annualized 16.93%—a large performance gap. The Russell 3000 Index itself returned an annualized 13.79%. Though I present US returns below, such underperformance has generally persisted across global markets.
Notes: Data is from Morningstar. The Russell 3000 Index measures the performance of the largest 3000 US companies and is market-capitalization weighted. The Russell 3000 Value and Growth Indexes are subsets of the headline Russell 3000 Index and include securities with various “value” or “growth” characteristics, as defined by FTSE Russell.
So, what does this mean for PMA’s clients? Our clients get much of their exposure to value stocks through our “Conservative” equity portfolio allocation, which primarily contains large-capitalization value and “blend” (i.e, “style-neutral”) mutual funds which invest in these types of stocks in the United States’ market. PMA’s investment staff spends a significant amount of time evaluating these individual mutual funds in addition to calibrating their aggregated risk exposures when they are combined to create the collective “Conservative” allocation.
Importantly, when this “Conservative” allocation is combined with our domestic “Aggressive” portfolio allocation (containing mutual funds which primarily focus on stocks with stronger growth characteristics, also in the United States’ market), PMA currently targets a balanced allocation which does not have a large “tilt” towards either value or growth securities. This style-neutral exposure is intentional and is a facet of the risk control that we place a great deal of emphasis on in building our clients’ portfolios. A large tilt in one direction, for example, towards value stocks, can expose a portfolio to significant risks when these types of stocks are underperforming the broad US or international markets (as shown above).
Value investing does have a rich and successful history over the long-term in our industry. From PMA’s perspective, we will continue to watch these market dynamics closely. We still believe in the efficacy of the value investing style due to its long empirical track record and the intuitive risk- and behavioral-based rationales justifying its existence. In other words, we think that value investing will have a resurgence, but we cannot tell you exactly when or what may be the impetus for such a regime change. Similar to the way we view market timing with asset classes, we also do not believe that investors can time these types of strategies effectively through time. For that reason, maintaining a diversified allocation which contains a healthy balance of both value and growth stocks is a prudent strategy.
If you would like to discuss this topic in greater detail, or your portfolio’s specific allocation to value securities, please do not hesitate to contact your adviser.
¹For example, refer to: Is (Systematic) Value Investing Dead? AQR Capital Management. May 8, 2020. https://www.aqr.com/Insights/Perspectives/Is-Systematic-Value-Investing-Dead.
²For example, in 2020, Ted Aronson announced that his Philadelphia-based firm with a value orientation, AJO Partners, was closing and returning capital to investors. See: ‘Our Recent Performance Sucks.’ Here’s Your $10 Billion Back. Wall Street Journal. October 23, 2020. https://www.wsj.com/articles/our-recent-performance-sucks-heres-your-10-billion-back-11603461621.
³An Exceptional Value Premium. Dimensional Fund Advisors. October 5, 2020. https://www.dimensional.com/us-en/insights/an-exceptional-value-premium.
⁴A balanced allocation is also targeted in the International equity portfolio allocation.